Bulletin: MA000003

Dear Associates:

We have recently experienced an increase of underwriting and policy preparation questions involving situations whereby the lender's policy is in an amount greater than the owner's policy. This increase in question is due, for the most part, to a commensurate increase in construction loans and certain government loans which absorb closing costs. In the construction loan context, the issuing office should be concerned with the issue of "underinsuring" owners.

A hypothetical scenario is described as follows:

Owner purchases unimproved lot for $50,000.00 and simultaneously obtains a construction loan for $150,000.00.

Lender is insured for $150,000.00.

Owner is insured for $50,000.00.

"Anticipated full value" of the property, after improvements, is $250,000.00. In the event there is a successful claim on the lot/insured premises involving total loss of title, the insured lender will be entitled to $150,000.00, if the principal amount of its loan is still in that amount at the time of the claim. The insured owner will be entitled to no recovery whatsoever from the title insurance company.

Thus, an insured owner may not be able to recover the full value of the insured premises, on a loss, if he is underinsured.

In the construction loan context, if the amount of the owner's title insurance is less than the amount of the lender's title insurance, the owner should be advised that he may be underinsured and that he may be able to insure the property for its "anticipated full value".

If the owner requests to insure the premises for its "anticipated full value", that value can be determined from an "as-built" appraisal. In most cases, the lender will have required that such an "as-built" appraisal of the property be obtained as part of its approval of the construction loan. That appraisal can be used as evidence of the value of the property upon completion of the improvements. This will allow the amount of the insurance to be issued to the insured owner for the property's "anticipated full value", subject to a "pending improvement clause", as follows:

"Liability under this policy presently limited to the purchase price of the land, $ (the current value of the property at the date of the policy), but will increase in accordance with the value of improvements erected thereon, in good faith and fully paid for, but liability under this policy shall never exceed the face amount of this policy. (This does not apply to Loan Policies.)"

If the "anticipated full value" cannot be reasonably determined at time of purchase or if the insured owner declines to purchase a policy in the amount of the "anticipated full value" at time of purchase, the agent may issue an owner's policy in the amount of the original purchase price. However, the following provision must be added to the bottom of Schedule B of the owner's policy:

"The amount of insurance provided herein to the insured owner is provided at the request of the insured owner. The insured owner has been advised of the availability of insurance in the amount of the anticipated value of the insured premises after improvements, but has elected to request insurance only in the amount shown on Schedule A despite the coinsurance-insurance provisions of Paragraph 7(b) of the Conditions and Stipulations of this policy."

Once the improvements to the premises are completed, an endorsement to the policy may be issued to increase the amount of coverage to the full value of the property. Remember, though, an additional premium will be due in order to increase the amount of coverage. The additional premium will be simply calculated by charging the insured owner a fee equivalent to $2.75/$1000.00 for the increased amount of insurance. It is important to note that if the policy had been originally issued in the amount of the "anticipated full value", as described above, the owner could have taken advantage of the lower premiums associated with the simultaneous issuance of lender's/owner's policies and would have incurred some cost savings.

In the government loan context, if the amount of the lender's title insurance is greater than the amount of the owner's title insurance it is usually due only to absorbed closing costs. In these instances, the agent does not have to be concerned with the issue of "underinsuring" owners and does not have to add any special provisions to the policy.

Should you have any questions, please contact us at 617-737-8240.