The impetus of this article is simple – we are asked multiple times a day by well-intentioned investors... More...
As someone who writes prolifically about real estate and insurance, this article, as compared to others I have written, is relatively short, however, given some of the recent conversations I have had with investors and some of the recent classes I have taught, I feel it is necessary.
Unfortunately, insurance as a whole is normally viewed by consumers as a commodity or a ‘necessary evil’ that must be obtained when purchasing property and it is usually quoted and purchased with little or no actual knowledge of the policy itself on either the part of the buyer or even the agent providing it.
Because of this, as well as the nature of insurance law, the lack of professional knowledge had by many agents, and the many confusing semantics used within the insurance industry, there is a great deal of confusion between such terms as “Additional Insured”, “Additional Interest”, “Mortgagee”, “Loss Payee”, and “Named Insured” and they are used interchangeably as if they all mean the same thing – BUT THEY DON’T! Unfortunately, this confusion can result in unintended financial loss and unnecessary litigation far into the future and long after the policy has been first issued. All it takes is one claim or loss for the parties in the policy to find out how they really are, or are not, protected and that words actually matter.
For example, when working with investors and non-standard types of insurance situations, it is inevitable that the party requesting the insurance coverage asks to have someone else (usually the seller in a seller-financed transaction) inappropriately listed as an “Additional Insured” on the policy without understanding what he or she is really asking for. What the purchaser (and “Additional Insured Party”) fails to realize is that this provides absolutely no protection whatsoever for the party listed as the “Additional Insured” with regards to the physical property in the event of a physical or financial loss.
The purpose of this article is to finally, in real-life language, explain the difference in these terms so that you, the real estate professional and/or investor, are able to appropriately protect yourself and your interest in any property being insured, whether via wrap-around mortgage, traditional lending, or any other purchase scenario.
The term “Named Insured” refers to the owner of the insurance policy and it is the party listed on the Declaration’s Page. The “Named Insured” is the only party that has authority to make any policy changes, file claims, receive refunds and claim payments, cancel the policy, or make any other such modifications.
In addition, the Named Insured MUST have a primary insurable interest in the property and be the titled owner.
This is probably the single most misunderstood insurance term that is misused and misapplied on a regular basis. An “Additional Insured” is a party listed on an insurance policy that has some type of liability interest in the property. The “Additional Insured” has absolutely no right or authority to make any policy changes or to cancel the policy. Also, contrary to popular belief, an “Additional Insured” is ONLY afforded liability protection under the liability portion of the policy and there is no coverage whatsoever for physical losses resulting from such things as vandalism, theft, fire, wind and hail, and so on.
For example, with regards to residential property, if a property were seller-financed and the seller was actually carrying back a mortgage note and they were listed as an “Additional Insured” on the policy instead of as a mortgagee (described further below), then in the event of a physical loss (the home burned to the ground), the seller would have absolutely no legal right whatsoever under the policy to receive claim funds to pay off the mortgage debt and/or there would be no control of managing claim funds to ensure repairs.
However, if there was litigation involving the property or its use and the “Additional Insured” was named in the suit for any reason, the policy provides liability protection for legal and defense costs for the “Additional Insured” and the insurance company issuing the coverage would have a ‘duty to defend’ any and all “Additional Insured parties” listed in the policy. The most common example of this actually involves commercial policies, such as general liability, whereby a general contractor, for instance, may be listed as an “Additional Insured” on a subcontractor’s insurance so that in the event of a liability claim caused by the subcontractor (such as faulty work, property damage, or bodily injury) where the general contractor is also listed in the suit or claim, he or she receives coverage for legal and defense costs from the subcontractor’s policy.
Many buyers and sellers in a wrap-around mortgage transaction prefer to have the seller listed as an “Additional Insured” rather than as a “Mortgagee” simply because they don’t want to blatantly alert the underlying lender that there has been a transfer of the property. The unintended consequence of this, however, is that the coverages and protections afforded to the seller (who is technically a second mortgagee) are greatly reduced and limited now to liability protection only.
An “Additional Interest” is nothing like the “Additional Insured” though they sound similar. An “Additional Interest” is a party listed in an insurance policy that has an “interest” in being notified whenever a policy cancels or has a major change made to it. In other words, this party is simply being made aware of the change – nothing else. There is absolutely no coverage whatsoever afforded to an Additional Interest. An example of a party who may need to be listed as an “Additional Interest” is a loan servicing company who is managing the loan for a seller-financed transaction. The servicing company has no insurable interest in the property and has no coverage under the terms of the policy, but it does have an interest in being notified if or when the policy is canceled so that it may contact the mortgagee and either have the policy reinstated or request updated proof of any new replacement policy.
It is important to understand that Mortgaee’s and Additional Insured’s automatically get notifications of all policy cancellations and/or major changes and that only other parties associated with the loan in some capacity (but have no insurable interest) should be listed as “Additional Interests”.
The “Loss Payee” is another very misunderstood term which is most often associated with automobile loans – though it is very applicable to commercial and residential property as well. In regards to insurance, a “Loss Payee” (which automatically includes any mortgagee) is the party (or parties) to which any payment being made under the policy in relation to a claim or loss will be made before being released directly to the Named Insured.
For example, assume that you own a property for which “XYZ Bank” is the mortgagee. A kitchen fire occurs in this property and a claim is filed for the damage, which is estimated to be at $85,000. When the insurance company releases the $85,000 claim check, it should be made out to both you (the Named Insured policy owner) as well as XYZ Bank (as the mortgagee and loss payee). This means that XYZ Bank must verify the claim and then endorse the check over to you – or the contractors performing repairs – before it may be cashed. The reason for this is simple; XYZ Bank has a financial interest in the property via the mortgage loan and they want to make certain that they maintain control of the loss payment to ensure that the loan is either paid off (in the event that repairs are not performed) or that the money does in fact go towards repairing the property that is collateralizing their loan – and not to paying for your upcoming ‘around the world’ vacation.
So far we have described the difference between an Named Insured, Additional Insured, Additional Interest, and a Loss Payee; now let’s discuss the true meaning of what a “Mortgagee” really is.
A “Mortgagee” is the entity that actually originates and holds the Promissory Note and Mortgage loan on real property; otherwise known as the bank or the mortgage lender. The Mortgagee extends financing to the “Mortgagor” – who is the homeowner or borrower in the transaction.
By default, all Mortgagees listed in an insurance policy are also automatically considered as “Loss Payees”, meaning that, as in the section above, any claim payments should theoretically be made to both the Named Insured as well as every Mortgagee listed. If a party who has made a mortgage loan to the Named Insured is not listed in the policy, whether intentionally or unintentionally, then that Mortgagee will not be afforded any rights or coverages under the terms of the policy itself.
As you can see, there is a big legal difference between these terms and having an interest listed incorrectly can have unintended and far-reaching consequences in the event of a loss, default, or other such situation. Your agent should know the difference between these five terms, however, the reality is that the vast majority of licensed agents are salespeople with quotas to meet and they seldom, if ever, deal with investor-related transactions and therefore often don’t know the difference between these coverage position themselves. If you have any questions or would like to discuss your own insurance needs, please feel free to call us at (800) 299-8994 or email us at firstname.lastname@example.org