As published in Scotsman Guide's Commercial Edition, February 2007.
Would it be wise for a lender to hand its borrowers a blank page and ask them to draft all the terms and conditions of the loan agreement? Do lenders compete in the marketplace by doubling the closing costs of other competitive lenders?
Yet many lenders effectively are now doing just that. They are making critical errors in environmental-risk mitigation and cost management by remaining uninformed about the current status of the environmental-insurance market.
Lender environmental-insurance policies often offer better protection at a lower cost than policies primarily directed at covering the borrower. Many lenders, though, do not realize the policies still exist.
Failure to recognize this can be costly. Deals can fall through because the lender does not have cost-effective environmental insurance. As a broker, therefore, it may be wise to encourage your lenders to look into lender insurance.
Stress the benefits
Lender environmental policies can offer the best protection for lenders because they make the lender the "sole insured." Lenders do not need to share policy limits with the borrower. Additionally, carrier risk-tolerance expands with these policies because the possibility of loss becomes more remote. And the cost decreases because coverage generally will not be triggered unless there is a default.
Borrowers can also benefit from the lower cost of these policies. While the policies do not provide coverage for the borrower, many borrowers are more interested in price reductions than in being named on the policy. The typical borrower wants to keep closing costs as low as possible.
The lender-controlled-insurance process also saves borrowers the time and effort that it would take to track down a quotation themselves. And overall, insurance is easier to obtain on borderline-risky sites when it covers the lender, rather than the borrower.
Most lender policies provide "lesser of" coverage. This means that if pollution is discovered at the collateral property and the loan goes into default, the lender pays the outstanding loan balance or cleanup costs -- whichever is less. This product often is acceptable to third parties, including those in the securitization process.
Take the lead
Environmental insurance is not like other lines of insurance. It must be placed through an insurance broker. The lender should, therefore, maintain or develop a relationship with a qualified broker who can obtain a policy proposal that protects the lender.
The lender also should take control of the environmental-insurance process. This will ensure that the policy, which is generally highly variable -- depending upon the circumstances of each property and loan -- meets the lender's needs.
It is risky to leave these decisions in the hands of the borrower and the borrower's insurance broker. They are usually less motivated to protect the lender's interests. Further, neither party may know the type of coverage that would most efficiently and effectively protect the lender.
For example, consider a lender that required environmental insurance for a loan on a collateral property that once housed an on-site dry cleaner. No subsurface environmental work had been conducted at the site. The lender merely asked the borrowers to provide the results of a Phase II environmental site assessment showing the site was "clean" or to purchase environmental insurance.
As a result, the borrower obtained a borrower-policy option. This proposal contained no coverage for pre-existing conditions and was inadequate to protect the lender against risks from the prior dry cleaner.
Had the lender taken the lead, it could have discovered that it was possible to obtain a policy with a lower premium that would cover the lender exclusively and that would cover pre-existing conditions.
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