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Rethinking Your Approach to Insurance

Aug 15, 2021 | By JOSEPH CIOFFI

There are pitfalls that those in asset-based financing should be mindful of, particularly when it comes to insurance and protecting collateral against loss. We spoke with Jack Schwartz, managing director of Davis+Gilbert Risk Management LLC, about key issues to keep in mind when buying policies. Jack has been working with clients for over 15 years with a particular emphasis on real estate and lending transactions.

In your experience, do lenders and investors appreciate the importance of insurance?

The good news is yes, lenders are generally aware of the need to protect assets they’re lending against — and specifically, to have some sort of insurance requirements on them. The bad news is that they don’t give enough thought to the kind of insurance they require. If I had a dollar for every inadequate insurance policy I’ve run across in the last 15 years, I would be writing this from my yacht.

What kind of mistakes can lenders and others make in acquiring insurance?

The most consistent mistake I see lenders make is not about getting any specific term into their policies, but in getting the right people on the job. Insurance is a specialized product that demands expert attention. All too often, uninformed professionals are tasked with handling insurance, which can lead them to buying largely worthless policies.

Can you give an example?

I was just asked to review an insurance quote for a pending acquisition awaiting loan approval. The bank had tentatively approved insurance covering both physical damage to the asset and liability arising from its operation. But the liability coverage was just an illusion, given the large number of coverage exclusions in the policy, many of which would have been triggered by the buyer’s intended use of the asset. It seemed obvious that the lender either didn’t understand how the buyer was going to use the asset or simply hadn’t reviewed the policy endorsements with the exclusions. The bank representative likely never read the policy endorsements since no such task is included in their checklist.

Have you found a good checklist sufficient to avoid unintended consequences?

No. Using boilerplate insurance requirements or checklists on a mass scale basis is a bad practice, as it overlooks the unique circumstances that apply to any particular risk.

Insurance policies are very nuanced. Just as lawyers are hired to ensure the wording of a contract is favorable and that its terms can be complied with, insurance policies should be viewed in the same manner.

What kind of risks are people underestimating?

I’ll give you a specific example — renting out workspaces in commercial buildings or homes through services like Airbnb. Each scenario presents unique risk exposures that require a careful, detailed-oriented approach to insurance coverage. Similarly, advanced technology in cars, homes, and buildings should be taken into account. It’s not unforeseeable that a self-driving car, for instance, could be hacked and involved in a serious accident. Ignoring how an insurance policy would (or would not) protect an asset in such situations can lead to catastrophic results.

What are the three main areas where you see the largest risks and do you have any practical tips that could help clients minimize exposure?

Lenders are pretty well-attuned to the biggest risks that apply across a wide range of assets. They are generally good at recognizing weather-related risks, for instance, and will require flood, earthquake, and windstorm insurance for assets that warrant it. As for practical tips, I have four.

  • First, when thinking about the insurance coverage on an asset, lenders should be mindful of the various ways that the asset is used. That will help them consider all the risks that need to be covered.
  • Second, this may sound obvious, but review the actual insurance policy and all endorsements; that will tell you whether the coverage is lacking or the exclusions too broad.
  • Third, have someone who understands insurance draft insurance requirements and review the borrower’s insurance policies.
  • Fourth and finally, I would encourage lenders to take a holistic approach to insurance review that allows them to be flexible with checklists. The most important thing is to understand each individual asset being insured, and the risks to protect against.

Looking Ahead

Given the uncertainty of the times and so many factors impacting the ability of borrowers or counterparties to perform, collateral valuation and its protection against loss are paramount concerns. As Jack mentioned, lenders and others at risk of loss can no longer rely on “standard” terms or those that seem “good enough” because they may have been acceptable in the past. It’s also in the insured party’s interest, as the one at risk, to be actively involved in ensuring the terms of protection are tailored to the purpose.

Learn more about Davis+Gilbert Risk Management and Jack’s services by visiting here.