Does your Insurance Cover your Loan Value?
Take a quick look at your hazard insurance amount versus your loan amount. This is assuming you have a loan on the purchase of the land and building where you operate your business. If there is a fire or catastrophic event destroying the building, then is your insurance enough to cover the loan value or was it based on the insurable value of just the building? Many business owners do not know the answer until it is too late.
As part of the loan process, there will be an appraisal of the collateral. The appraisal will provide two numbers. The “as is” market value and “insurable” value.
As-Is Market Value vs Insurable Value
The “as-is” market value is exactly what it says it is. It is simply the market value of the collateral (both the building and the land together) in its then current existing condition. The “insurable” value is essentially a value of the destructible improvements on the premises, such as the building. It would be the replacement cost of the building, excluding the land. That is why the “insurable” value is less than the “as-is” value.
Obviously, it is best for the borrower to have enough insurance to cover the loan value. However, insurance companies will focus on the replacement value of the building, i.e., the “insurable value.” Insurance companies believe that insuring an amount that exceeds the “insurable” value is over-insuring, as the rest of the insurance would then be for land or real estate that cannot generally be destroyed.
Understanding Your Loans as a Business Owner
In 26 years of practice, too often have I encountered business owners suffering an event destroying their business. They believed they were sufficiently insured. They believed the lender would never allow a loan to close without some form of insurance to at least cover the loan value. Their belief is destroyed when insurance proceeds are paid directly to the lender (as the additional insured on the policy). The lender then notifies the business owner they are in default of the loan since the collateral is destroyed and/or the owner is in default for not making loan payments due to no business generating money to make the loan payments.
That is when the owner understands the difference between loan value, as-is market value and insurable vale. As a business owner with a loan on your building, it would not hurt for you to take a quick look at your insurance in comparison to your outstanding loan. You can simply pick up the phone or email your insurance broker and/or lender and ask. Best you know now versus discovering the difference, after a catastrophic event impacting your business. Should you need attorney assistance, contact our lawyers today to see how we can help.