By Ronald M. DeHaan

Insurance is a critical element in protecting real estate interests.  Both an Owner and a Mortgage Lender have economic values protectable by insurance.  Those economic values, while sometimes coincidental, may also be divergent.  Lenders will insist that Borrowers, pledging an interest in property to the Lender, maintain insurance on that property in an amount sufficient to pay or substantially reduce the amount of the loan secured by the pledged property.  As part of the Loan Agreement signed by a Borrower, there is, typically, a clause requiring the Borrower to maintain insurance on the pledged property, at the Borrower's expense.  Should the Borrower, for any reason, fail to do so, the Lender reserves the right, again at the Borrower's expense, to obtain and maintain a policy of insurance on the pledged property.  A policy of insurance obtained by the Lender is called a forced place insurance policy (hereinafter Lender-Placed).

A Borrower's insurance policy may be cancelled for a number of reasons, including non-payment of premiums or an insurer perceived increased hazard.  Insurers often take the position that once a replacement insurance policy is provided on the property by either the Borrower or the Lender, the original insurer is no longer responsible for any loss covered under the terms of the original insurance policy.

Questions, therefore, arise about whether the Lender-Placed insurance policies are replacement policies.  Lender-Placed policies are usually not deemed to be replacement policies.  While Lender-Placed policies may insure covered repairs at replacement cost and not just the unpaid mortgage balance, coverage under Lender-Placed policies usually will not be provided for contents of the pledged property or liability arising out of or connected to the use of the insured property as those claims may be difficult to prove and inure solely to the benefit of the Borrower, without benefiting the Lender.  Lender-Placed policies typically cost between one and one-half to two times the amount of the Borrower's purchased property insurance policy.  That is because a Lender-Placed insurer often agrees to cover every lapsed policy of that Lender's portfolio, regardless of condition of the property, on a sight-unseen basis.

To avoid incurring the additional cost of a Lender-Placed policy, Borrowers should make sure their Lenders have received copies of current insurance policies or Certificates of Insurance issued by insurers who meet the requirements of the loan documents.  If a Borrower decides to replace the Borrower's insurer with another insurer, the Lender should be notified of the change so that the new policy or Certificate can be issued to satisfy the Lender that the Lender's interest in the pledged property is being protected.