UK: In an Active Insurance Market - Some Points you Used to Know but Can´t Quite Remember!

Last Updated: 19 June 2002
Article by Shelagh McKibbin

There is nervousness in the insurance market and evidence is emerging that key reinsurers are applying a blanket exclusion of perils from terrorism. This sensitivity has brought the insurance provisions to the fore in lease negotiations. Tenants are alert to the issues and the potential uninsured risks. Both they and other parties with an insurable interest in the premises are scrutinising landlords policies and looking carefully at the cover they provide.

In this market, a review of first principles and common terminology is warranted.

The basic position

A straightforward insurance policy of a commercial building will generally be taken out by the landlord in its own name. In most cases there will be a general noting of tenants’ interests. Often, there will be no specific reference to the interests of a tenant’s mortgagee. In reality, this may represent only a snap shot of the insurance position on the property. There may be a number of other insurable risks which require full protection under the policy: a freeholder, a landlord, a tenant, a mortgagee, an administrator, an executor, a contracting buyer may all have insurable risks. It is the manner in which these interests may be recorded on the policy that can cause argument and unnecessary delay.

The terminology

The landlord’s interest will appear on the schedule as the principal insured.

Third party interests require closer scrutiny. Several terms and phrases are referred to in legal documents and in insurance documentation. These are joint insured, dual insured, composite insured and parallel insured, on the one hand, and interest noted or general interest on the other. The impact of each of these is set out in the tables.

The umbrella term generally used to describe policies in which more than one entity has an interest is "co-insurance".

Any policy insuring more than one entity where those entities do not have identical interests is a composite policy, in other words a number of separate contracts of insurance between each composite insured and the insurer in respect of their separate interests. Any policy where the landlord, tenant and mortgagee are named insureds will almost certainly be a composite policy.

Joint insurance describes a policy in which more than one entity has an identical interest. There are in practice very few such situations - a husband and wife insuring a property as joint tenants for example. Note that any breach of the policy, fraud or other wrongdoing by one insured will affect the rights of the other (innocent) joint insured.

The expressions "dual insured" and "parallel insured" are not terms of art - a Court would review the policy to decide whether on the facts the relevant parties were joint or composite insureds.

In order to determine who are insured parties, it is necessary to check the definition of "insured" in the policy/policy schedules, or in any other memoranda or endorsements. An entity may be an insured by virtue of being a member of a class described (for example, successors in title).

Another common misunderstanding is the difference in meaning and effect of joint insured and joint interest. The names of jointly insured parties appear on the face of the policy. This must be distinguished from a “joint interest” where two or more parties have an interest which is indivisible e.g. partners in a partnership. It is preferable to avoid the use of the first of these to avoid confusion with the latter.

COMPOSITE INSURED
KEY FEATURES:
  • The name of all insured parties appears on the face of the policy.

  • The interests of each party are divisible (contrast with “joint interest”).

  • Each party effectively has its own contract with the insurer.

  • If one insured party is guilty of a non-disclosure/breach of the policy/fraud, the other innocent insured party or parties are still ordinarily entitled to an indemnity under the policy.

When an interest is noted on an insurance policy, it does not appear on the face of the policy but it is noted on a separate endorsement or memorandum. There can be scope for confusion as to what rights are conferred on a party whose interest is noted on the policy. If the intention is that such a party should be entitled to receive any insurance proceeds, then this ought to be clearly stated on the face of the policy document. The concept of noting of interests is inherently less satisfactory than composite insurance because, in effect, the beneficiary of a noted interest follows the fortunes of the named insured. So, for example, if the insured is guilty of a breach of the policy or fraud and the policy is avoided, the beneficiary will not be able to recover separately.

For this reason, parties often insist on composite insured status but this can cause practical issues for landlords with large property portfolios insured under block policies.

INTEREST NOTED (GENERAL OR SPECIFIC) 
KEY FEATURES:
  • Where a specific name is noted on an insurance policy, it does not appear on the face of the policy but it is noted on a separate memorandum.

  • Some policies contain a general interest clause identifying a class of interested party e.g. tenant or mortgagee and the obligation is to notify the insurer of the specific identity of an interested party after a claim.

  • Where an interest is merely noted or covered by a general interest clause, the beneficiary follows the fortunes of the named insured e.g. if the insured is guilty of a non-disclosure, breach of the policy or fraud and the policy is avoided, the beneficiary will not be able to recover separately.

  • There is no separate contract with the insurer. The noting is merely an indication to the insurer that the noted party has an interest in the proceeds and that no claim can be settled without his consent.

It should be noted that a tenant is likely to require a specific waiver of subrogation in the insurance policy. If a tenant is not a composite insured, an insurer may be able to exercise rights of subrogation (in other words, stand in the landlord’s shoes to pursue a claim) against the tenant in relation to damage caused or contributed by the tenant, irrespective of whether the tenant is responsible for the insurance premium under the terms of the lease.

In addition, insured parties generally look for non-invalidation wording in the policy. There is no “standard” approach but in effect the insurer confirms that the insurance will not be invalidated by any misconduct of an insured party who is seeking to make a claim. This is of particular importance for a party whose interest is merely noted on the policy.

SUBROGATION RIGHTS (AND WAIVER)
KEY FEATURES:
  • By virtue of the doctrine of subrogation a person may in certain circumstances “step into the shoes” of another so as to enjoy the latter’s legal position or his rights against a third person.

  • The right of an insurer to subrogation embodies two principles:

    • the insurer is to receive the benefit of all rights and remedies of the insured against third parties which, if satisfied, will extinguish or diminish the ultimate loss sustained – i.e. the insurer can exercise such right in the name of the insured; e.g. as landlord against the tenant for breach of its obligations in the lease.

    • the insurer has the right to claim from the insured any benefit received by the insured as compensation for the loss in respect of which the insurer has paid out.

  • The right of subrogation vests by operation of law – it is not the same as an assignment of such rights.

  • The right of subrogation cannot be exercised by an insurer until payment has been made by the insurer to the insured.

Banks and other mortgagees that lend on the security of property will also seek to protect their interests. A landlord's mortgagee is likely to require composite insured status. As discussed earlier, this will ensure that the mortgagee is involved in any negotiations following damage by an insured risk. However, reinstatement provisions in the lease will generally override any conflicting provision in the loan agreement for repayment of the loan on such event.

Alternatively, the landlord's mortgagees interest may be referred to in the insurance policy as that of loss payee. This is a phrase more familiar to lenders than real estate practitioners. A loss payee clause operates as an assignment of the right to receive the proceeds of insurance. A loss payee may be a potential recipient of the proceeds in appropriate circumstances, a position not dissimilar to that of a person with a noted insurable interest. Whether a loss payee clause operates as an effective assignment of the policy proceeds will depend upon the drafting of the clause. if it does not, the loss payee will not be able to sue the insurer.

LOSS PAYEE/PAYABLE CLAUSE 
KEY FEATURES:
  • A loss payable clause does not make the mortgagee an insured party but it does operate as an assignment of the right to receive the proceeds of insurance. The clause is in effect a request by the mortgagee to the insurer and operates as a charge on the proceeds by way of a partial equitable assignment. On that basis the insurer cannot pay the mortgagor direct or apply the proceeds to rebuilding without the mortgagee’s consent. If it does, it risks having to pay the claim twice. However, as a mere assignee, the mortgagee’s claim can be defeated by any default of the insured, which would entitle the insurer to deny liability.

  • It is generally understood that insurers consider the nomination of a lender as loss payee as providing the same degree of protection as an assignment of the right to recover the proceeds under the policy.

  • It is common to include a non-invalidation provision (i.e. no act or neglect by the principal insured or the mortgagor will invalidate the insurance) to support the loss payee’s position.

A changing market

It has been the market practice to rely on the loss adjuster to investigate the interests of all parties to the policy and to determine how the monies will be distributed. This procedure has generally not differentiated between the named insured and those with interests noted. However, this is a market when insurance premiums are rising, reinsurance is under careful review and the approach of insurers can seem inconsistent. Insurers may now look for opportunities to avoid paying out. Tenants and mortgagees and their advisers will be looking to ensure that their insurable interests are now properly protected.

© Herbert Smith 2002

The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

For more information on this or other Herbert Smith publications, please email us.

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