Avoid being surprised by bank interest clauses in real estate lending

Real estate lending has become trickier to secure since the financial crisis. In a move to de-risk their lending, banks are imposing even stricter conditions on their customers through the use of interest clauses.
The specifics of these clauses are variable, but their intention is, typically, to increase the control banks has over its customer’s insurance policy, and prevent its invalidation.
Although insurers understand the banking industry’s reasons for including these clauses, customers are often unaware of their impact and the unfavourable position they may unexpectedly find themselves in.
Insurers have seen a sharp increase in the number of requests for bank interest clauses, but there is still little or no formal guidance on the effect these clauses can have on real estate customers.
The clauses are often onerous in nature for both the insured and the insurer and require careful consideration as they increase the risk that insurers are writing and remove control from the insured.
Customers can easily fail to fully understand how detrimental the effects that these clauses can be in respect of their insurance arrangements.
Composite Insured
One of the clauses often included is “composite insured” also referred to as “non vitiation”, which in effect gives lenders equal status to the insured themselves. By including this type of clause, the lender’s intent is to ensure that the insurance policy cannot be invalidated in respect of the lender’s interest, regardless of any intervening events. Crucially, it gives lenders equal say over how claims are settled.
It means an insurer may have to accept instructions from the lender as well as the customer, even when this may not actually be in the customer’s best interests.
First loss payee
Another common clause, known as “first loss payee”, is intended to give lenders control over the payment of claims money.
This means that an insurer would be required to make the payment to the lender directly or alternatively in accordance with their written authorisation. At best, this would delay claims payments until such authorisation can be obtained.
Double Trouble
Complicating matters further, however, is that lenders will often ask for both composite insured and first loss payee clauses to be added together. The combination of such clauses can have very wide reaching implications for the insured.
An understanding of how these two clauses interact can be quite critical. While first loss payee means that in the event of a loss the lender becomes the key decision maker under the policy, the inclusion of the composite insured clause also means that the lender is free to negotiate settlement of the claim within the terms of the policy coverage.
It means the lender can agree settlement of the claim in accordance with their own priorities, which may not always be aligned with your own.
In summary, the handover of control to the lender will almost certainly lead to delays in the claims handling process and has the potential to also allow claims to be negotiated and settled leaving the customer insufficiently compensated for their loss and unable to recover their financial position.
What to do next? 
If you would like to talk to an expert for more information about your insurance programme, or to discuss any other risk or insurance need, please give us a call. 
Call 01789 761660 
Web: www.pi-propertyinsurance.co.uk

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