04 August 2016

The Insurance Act 2015, which comes into force on 12 August 2016, alters a large number of these fundamental principles of insurance law for any policies entered into after that date.

The existing law, which has remained largely unchanged for over 100 years, has been viewed by many as outdated and too favourable to insurers. The changes introduced by the Act are intended to modernise the law and improve policyholders' ability to recover from their insurers. Two of the key changes are:

Duty of fair presentation

The central feature of the Act is to replace the insured's duty to disclose all material facts with a duty to give the insurer a "fair presentation of the risk being insured". A failure to present such risk fairly does not (as a failure to disclose current does) automatically allow the insurer to avoid the policy in its entirety. Instead the insurer's remedies vary in severity, depending on what the insurer can show it would have done differently if the insured had complied with its duty of fair presentation.

Breach of warranty

The Act has also changed law relating to warranties. Under the current law any breach of warranty, no matter how trivial, automatically renders the policy void from the date of breach. For policies entered into after 12th August 2016: (1) any breach of warranty will suspend the policy until that breach is remedied (if it can be); and (2) insurers may only rely on a breach of warranty to escape a claim if the breach of warranty was relevant to the type of loss suffered by the insured.

The changes implemented by the Act are not mandatory and insurers and insureds are allowed to 'contract out' of the Act. However, there are strict rules that must be followed in order to do so and the parties should state clearly what arrangement they are contracting into.

How do these changes affect property lenders?

When considering insurance over secured property a property lender relies on distinct contractual relationships with two parties; (1) the insurer and (2) the insured (the borrower).

The effect of the Act therefore needs to be considered in the context of each of these relationships. Before doing that it is however useful to have a reminder about the type of insurance protection a property lender should be looking for.

What rights and protections does a property lender need?

It is now standard practice for the insurance policy relating to secured property to be on a composite basis. This means that the property lender has his "own" policy with the Insurer albeit on the same basic terms as the borrower's insurance policy.

Insurance arrangements that have previously been acceptable (such as a property lender being joint insured with the borrower or with the property lender's interest being "noted" on the insurance policy) are now unlikely to be acceptable. The latter arrangement in particular should be avoided in all circumstances as any legal benefit that such noting provided largely disappeared following the end of the protocol between the British Bankers' Association ("BBA") and the Association of British Insurers ("ABI") in June 2012.

The key advantage of a composite insured policy (distinct from a joint insured policy) is that any action or omission by the borrower that might permit the insurer to declare the policy void (or suspend cover) will not affect the separate interest of the property lender. The principle is enshrined in a number of standard clauses that the property lender should require including: a "non-vitiation" clause, a "non-invalidation" clause, an ability to insure at the cost of the Borrower if the Borrower fails to do so; and provisions that make it clear that there is no obligation on the part of the property lender to make any disclosure to the Insurer in relation to the insured assets other than when it is mortgagee in possession.

In addition to being named as a composite insured on the policy, the property lender will also usually expect the policy to provide that the lender is "first loss payee" for payments above a certain threshold.

So how does a property lender manage its relationships with the insurer and the insured to ensure that insurance is in place that meets these requirements and how does the 2015 Act affect this?

The relationship with the insurer

As outlined above a property lender should expect to have an independent relationship with the Insurer due to being named as a composite insured on the policy.

Understanding the terms of the policy and whether or not it is satisfactory is an important part of due diligence at the loan origination.

In most cases this due diligence will involve an insurance review supported by a "broker's letter" from the insurer or a broker confirming the terms of the policy in place.

The Loan Market Association ("LMA") issued a standard form of insurance broker letter in February 2016 which was drafted in conjunction with the Association of British Insurers and the British Insurance Brokers Association, in an attempt to stop a lot of the delays/negotiation around the form of letter provided. If a broker issues a letter in the LMA form the property lender has confirmation that its interests are fully protected in accordance with the principles outlined earlier.

The Insurance Act 2015 does not change the level of protection a property lender should require or the need to undertake appropriate due diligence. However the changes introduced by the Act will alter a number of the policy terms between the Insurer and the Insured. Property lenders and their advisers need to be aware of these changes when reviewing policy terms and agreeing forms of broker's letter and the letter is likely to need to be updated for use with policies that are subject to the Insurance Act 2015.

The relationship with the insured (borrower)

In addition to the initial protection offered by due diligence, a property lender relies on insurance covenants in facility and security documentation during the period of the loan. These will require the borrower to effect insurance on acceptable terms and to ensure that both the borrower and the property lender's interests in the insurance policy are maintained.

As with the form of broker's letter the precise wording of these covenants will need to be reviewed to ensure that the obligations that it imposes on the borrower work equally well with a policy that is subject to the Insurance Act 2015 as a policy governed by current law. For example any existing covenant imposing a duty to disclose may need to be extended to include a duty to fairly present the risk insured to the insurer.

Understanding lender protocols on insurance

Many property lenders now have internal transaction execution teams who review insurance policies and the form of broker's letters or a relationship with independent professional advisors to provide that service.

The LMA standard form of broker's letter has not become "market standard" and individual Lenders are increasingly looking to agree standard forms of broker's letters with some of the major insurers and broker firms in order to make transactions run more smoothly.

Lenders should also not forget that insurance policies usually last for a period of no more than 12 months. Indeed on a refinancing the unexpired period of an existing insurance policy may be much shorter than this. The protection offered by the due diligence undertaken when the loan originates (including any brokers letters obtained) will be lost when the policy is renewed.

Lenders need to consider analysing all new policy terms to ensure a similar level of protection continues throughout the lifetime of the loan. This could most easily be done by obtaining a broker's letter on each policy renewal date but that might meet with resistance from Borrowers for cost reasons. At the very least lenders should be considering a review of new policy terms to ensure that they offer a similar protection to the policy that was reviewed on loan origination.

For more information, please contact Sally Jupp.

Key contact

Richard Leeming

Richard Leeming Partner

  • Banking and Trade Finance
  • Derivatives, Debt Capital Markets and Securitisations
  • Real Estate Finance

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