Banks usually require a borrower to provide a mortgage on their property as security for the bank's loan. However, under China's laws, a mortgagee is not entitled to directly receive insurance benefits or indemnification relating to the mortgaged property. If the mortgagee cannot be directly indemnified when the mortgaged property suffers damage or loss, the mortgagee bears the risk of being under-secured on its loan since it does not have a priority right to the insurance proceeds. Although the mortgagee can seek indemnification from the borrower if the borrower has been reimbursed with insurance benefits, ideally the bank should directly receive indemnification for the loss in value of its security.
In practice, the lender bank usually requires the borrower to insure the mortgaged property and designate the bank as the "first beneficiary" in the property insurance contract. In this way, the bank can directly obtain indemnification if the mortgaged property suffers damage or loss due to insured incidents. However, under the Insurance Law of the People's Republic of China ("Insurance Law"), the term "beneficiary" is only defined in life insurance rather than in property insurance. On September 23, 1992, the Department of Real Estate Credit of the Construction Bank of China promulgated the Interim Measures of Employees Mortgage, which defined the term of "first beneficiary". However, the Measures for the Administration of Individual Housing Loans promulgated by the People's Bank of China on May 9, 1998 phased out the "first beneficiary" concept. Thus, since there is no definition for "beneficiary" in property insurance under China's current laws, the question of whether such a "beneficiary" is entitled to any direct claim to indemnity remains a myth in the property insurance contract. In order to clarify this issue, the High Court of Shanghai, in its 2009 and 2010 White Paper on Trial Judgments in Financial Cases, instructed that a beneficiary can only be specified in a life insurance contract according to the relevant provisions of the Insurance Law and instructions of the Supreme Court of China.
In practice, the People's Courts also hold the view that an insurance beneficiary refers specifically to the person who is entitled to claim for the insurance benefits in a life insurance contract. In disputes over property insurance contracts, the "first beneficiary" can only be receive insurance benefits after the insurance company has settled the claims of the insured and such a "first beneficiary" cannot claim the insurance benefits directly from the insurance company. Obviously, the People's Courts view the beneficiary of a property insurance contract and the beneficiary of a life insurance differently. The parties in a property insurance agreement designate a third person as the beneficiary of insurance benefits under conditions that the insured against incident occurs, and the nature of such an agreement is to create rights for the third person. Although this third person may be named as a "beneficiary", it contains a different connotation than the concept of "beneficiary" in the Insurance Law. The beneficiary of life insurance is the person who is entitled to claim for the insurance benefits upon the death of the insured. In the process of settling a claim, the beneficiary can bring an independent lawsuit in the court. In contrast, the beneficiary in property insurance is not entitled to claim for insurance benefits. The right to claim for insurance benefits pertains to the insured. The beneficiary can only be indemnified from the insured after the insured has obtained insurance benefits. Given that China's laws do not define or regulate the beneficiaries in property insurance contracts but rather have only defined the beneficiary concept in life insurance contracts, confusion may occur between the two types of beneficiaries.
In mortgage loans, the court may not recognize the lender bank as the beneficiary in a property insurance contract. As a result, the bank may face difficulties in seeking indemnification and in realizing its full security interest. From the jurisprudence point of view and insurance theory under the common law, this article will explore issues arising from property insurance contracts, including how to define the status of the lender bank (as a beneficiary or a third person) and how the lender bank can successfully obtain insurance benefits.
II. How a Lender can Directly Obtain Insurance Benefits as an Insured
In practice, when a borrower signs a mortgage agreement granting a mortgage in property to the bank, the bank often requires that the mortgaged property be insured.In such a property insurance contract, the borrower would be both the policy holder and the insured due to his/her ownership of the mortgaged property. The bank, on the other hand, would be designated as the "beneficiary" according to the endorsement slip issued by the insurance company. As mentioned above, once an insured-against incident occurs, only the borrower, as the insured, would be entitled to claim for insurance benefits from the insurance company.
Meanwhile, the bank would be in a relatively disadvantaged position – if the borrower does not submit a claim for insurance benefits, the bank would be unable to seek payment directly from the insurance company.
Article 12 of the Insurance Law provides that an "insured" means a person whose property, life or body is covered by an insurance contract and who is entitled to claim for insurance benefits. Thus in property insurance, the insured person has a statutory right to claim insurance benefits. What if the bank, instead of the borrower, were directly designated as the insured party in the property insurance contract so that the bank's ultimate right to indemnity is protected? Article 12 of the Insurance Law also specifies that the insured in property insurance shall have an insurable interest in the subject being insured at the time that an incident covered by the insurance occurs. Therefore, in order to answer the above questions, it is necessary to begin our analysis from the identification of "insurable interest".
A. Security Interests Qualify as Insurable Interests
Article 12 of the Insurance Law provides that insurable interest refers to legally recognized interest that the policy holder has in the subject being insured. This is the general definition of the concept of "insurable interest" under China's insurance laws. However, the Insurance Law does not specify what a "legally recognized interest" constitutes. In practice, the identification of an insurable interest is often in dispute. According to traditional legal theory, the owner has an insurable interest over his/her property basing on his/her ownership of the property, which includes not only possessory rights but also the rights of a security holder.
Ownership is the ultimate right over one's property, and it is an exclusive right which excludes others from using or enjoying the property. Damage to or loss of the property would cause direct economic losses for the owner of the property.
Thus it is easy to understand that the property owner has an insurable interest over his/her property. The realization of a security right is still based on the existence and the intactness of the property, but does not manifest as the right to possess, use or profit from a property. If the value of the subject property decreases due to accidental damage, the value of the security interest would be proportionally damaged as well. If the subject property is destroyed, a security interest in the property would vanish accordingly. Thus, damage to or loss of the secured property will ultimately weaken the security holder's priority right to realize on its security interest and have its claim satisfied. The concept of insurable interest was created in order to prevent the moral hazards of a person with no interest in the insured subject matter from collecting insurance proceeds.
If the insured has no interests in the intactness and existence of the insured subject matter, he/she may be reckless with or even destroy the insured property in order to gain insurance benefits, and that will make the insurance transaction akin to gambling. Therefore, since damage or loss to an insured property would jeopardize a security interest holder's priority right to have its claim satisfied, it has an insurable interest over that property and the moral hazard is negligible.
It is worth noting that security interest holder's insurable interest in the subject matter is different from that of the property owner, and can not exceed the value of the property. If debt relating to the mortgage is less than the value of the mortgaged property, the insurable interest should not exceed the sum of the original debts, interest, deferred interest and enforcement costs of the loan and mortgage.
B. The Disadvantages of Designating the Bank as an Insured
In accordance with the insurable interest theory, it would be feasible to designate the bank as the insured in a property insurance contract so that the bank is entitled to claim for insurance benefits. However, this approach would not work in practice due to the following reasons:
First, if an insured-against incident occurs, the insurance benefits would be directly advanced to the bank, as the insured. If this payment is considered as a payment towards the outstanding loan, it will accelerate the maturity of the loan. This would be unfair to the borrower, who may have been able to fully perform his/her duty of repayment. Therefore, the borrower may be unwilling to accept this kind of insurance arrangement which designates the bank as the insured in the mortgage and insurance contracts.
Second, according to the Insurance Law, although the insured is not a party to the insurance contract, he/she is a related person with some statutory insurance obligations, such as maintaining the safety of the insured subject matter, promptly notifying the insurer when the risk to the insured subject matter increases, and taking all necessary measures to prevent and mitigate loss or damage of the insured subject matter if an insured incident happens. Since the bank is not the owner or the actual possessor of the insured subject matter, the bank is unlikely to keep the insured subject matter in good repair or pay close attention to the increasing risks that may occur in relation to the subject matter insured. In addition, the bank may be hesitant to be designated as the insured in an insurance contract due to the additional costs of handling insured-against incidents.