Despite being a recommended method of evidencing cover, broker letters are often not fit for purpose and can cause unnecessary delays to real estate transactions. In this bulletin we discuss the relative merits of the other options available to ensure that borrowers can prove their compliance with loan facility agreements.
It is normally a requirement, when financing a real estate transaction by some form of loan facility or borrowing, for the interests of the lender to be noted in some way on the insurance policy. Before the financial crisis, this posed little concern as it was a simple matter to endorse an insurance policy. Nowadays the position is very different, and the onerous conditions and confused terminology between the insurance and financial worlds can lead to difficulties in producing the required evidence, leading to delays to transactions.
We discuss the limitations of the commonly requested broker letter and the benefits of the alternatives.
The LMA facility agreement
The standard insurance obligations set out in the Loan Market Association (LMA) facility agreement are such that the borrower has to implement substantial alterations to their insurance arrangements which will, in some circumstances, mean that their control is diminished. The lender becomes a highly protected composite insured and will receive claims proceeds where a loss exceeds a specified figure. Despite this, the agreement requires that the lender should only have a duty of disclosure if they ever became a mortgagee in possession. Some insurers simply will not accept that a lender will not have any duty of disclosure.
In some instance the LMA requirements do not match the terminology used by the insurer who may have their own view as to what is acceptable. Difficulties are also very likely to occur if the insurance is arranged by a superior landlord or tenant and the lease does not obligate them to arrange cover compliant with the borrower’s facility agreement requirements.
Individual lenders may then attempt to impose further obligations beyond LMA requirements on the insurer, e.g. giving notice to the lender of all alterations to cover that the insurer may feel they do not have the systems in place to be able to accept. Lenders may also insist that the insurer has acceptable security ratings from one or more agencies and require replacement insurance if these are not fully met at any time.
The problematic broker letter
The LMA and many lenders believe that the borrower’s insurance broker is best placed to provide evidence that the insurance meets the requirements of the facility agreement rather than the lender engaging their own broker, or a third party to carry out this due diligence work.
As a result, the idea of a ‘broker letter’ was introduced, aimed at creating a uniform way to state whether insurances are appropriate and conform to LMA requirements. The LMA Broker Letter template was modified in February 2016 and a 13 page set of accompanying guidelines was issued to lenders. This followed consultation with various parties but, importantly, individual insurers did not agree to the obligations detailed, and the major brokers required to complete the new template letter, including JLT, were not properly consulted. As such, the new letter has had little effect despite the expectations of lenders, and in our view this must be viewed as a missed opportunity to improve matters further.
The new template letter, like its predecessor, goes well beyond being a method for the lender to obtain details of the insurance in place and gain some comfort that this is broadly compliant with the facility agreement requirements. It is clearly stated that lenders will rely on the letter, rather than their own checks to ensure compliance, and in asking for details of broker’s professional indemnity insurance it shows that the lender would look to the broker if things went wrong.
This is despite the broker not being engaged by the lender and indeed acting as agent for the borrower.
Given their potential exposure, brokers have to operate within strict guidelines that their own legal teams dictate and any letter issued will reflect this rather than LMA’s requirements. An often overlooked point is that the broker can only ever confirm what the insurer has actually agreed to and any broker letter will therefore reflect this, as well as incorporating caveats and liability caps set out in their own template documents. Any alterations to the brokers’ own template will generally need to be specifically agreed with their own compliance and/or legal team, adding to potential delays.
Alternative LMA approved solutions
The potential delays and pitfalls from this approach are self-evident, and the LMA guidelines state that the broker letter template is a “starting point for negotiation only”. This is often overlooked and it can be questioned why the LMA and many lenders persist with this approach.
The costs involved in carrying out appropriate due diligence internally, or properly engaging a broker or other independent insurance consultant, may be a factor for any lender, but the LMA guidelines do mention that an independent review is indeed an alternative to a broker Letter. The Due Diligence team forming part of JLT European Real Estate provides such a service for a number of lenders.
A further, similarly overlooked, alternative approach mentioned in the LMA guidelines is to obtain a letter issued by the insurer. This approach is vastly more appropriate than a broker letter, as the insurer is the very party on whom the lender is seeking to impose obligations.
Such letters, or standard endorsements setting out the insurer’s response to the facility agreement obligations, are now readily available from most specialist real estate insurers and JLT have been successful in drafting letters for some other insurers to complete. These letters and endorsements give the lender an accurate understanding of what the insurer has actually agreed to, rather than a broker’s interpretation thereof, and will not cap liability beyond the sums insured.
It is our view therefore that insurer letters are the way forward. One major UK bank has fully embraced this already and has agreed a template acceptable to them with a number of insurers.
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For further information please contact Gary Pitt, Partner on +44 20 7558 3778 or email firstname.lastname@example.org