15. What does title insurance do?
Just as in the context of residential real estate, title insurance protects the insured, who can be the property owner and/or the mortgage lender, from loss due to undisclosed defects in title to real property and, for creditors, from loss due to the invalidity or unenforceability of its mortgage lien. Title insurance will defend against a lawsuit attacking the title as it is insured, or reimburse the insured for the actual monetary loss incurred, up to the dollar amount of insurance provided by the policy. Most policies contain a number of exceptions to the insurance policy, either specific exceptions for recorded liens, or general exceptions for issues the policy does not cover, including defects known to the insured, arising out of governmental documents not otherwise recorded, or arising out of creditors’ rights. Most title policies insure the title against both recorded and unrecorded claims, subject to stated exceptions. Coverage for unrecorded risks is beneficial because of the difficulty or impossibility of ascertaining all such risks. Many states have rating bureaus that regulate the types of policies, policy endorsements, and rates that apply to title insurance in a given jurisdiction. A creditor usually will require title insurance to insure the lien of its mortgage. Depending on the type and characteristics of the property and the loan, the creditor may also seek certain endorsements to the title policy covering a particular risk of concern to the creditor, such as insolvency. Those endorsements will affect the pricing for the policy. Endorsements may insure a whole variety of risks, including but not limited to zoning, usury, environmental liens, mineral rights, and other matters too numerous to list here. Certain endorsements are also only available in certain states or for certain types of properties or loans.
This is a very common question among business owners applying for a bank loan. Let's look at an example.
Bob wants to borrow $2 million from his local bank, to expand his business. His banker agrees to lend him the money, but wants to have life insurance in place on Bob's life. Why? Because if Bob tragically dies before the loan is paid off, his banker doesn't want to have to chase his wife or his estate for the money.
So, the race is on for Bob to get a policy. He wants that coverage quickly so he can close the loan and get his money. He gets prequalified for coverage, finds a company that will give him good underwriting, and submits an application. The application is approved, the policy is delivered, he pays for it, and the coverage is put into force.
Now he is ready to execute a collateral assignment. He gets a form from his bank, or from the insurance company – whichever the bank prefers – and completes it. His wife is the beneficiary, and the bank is the assignee. He gets the money from the bank and sinks it into his business.
Now let's suppose he unfortunately meets his demise a year later. His wife files a claim. The claims department of the insurance company pulls the file and notices that the benefit has been collaterally assigned to the bank. They contact the bank and ask for documentation of any outstanding balance on the loan. The bank provides this, gets paid, and then Bob's wife gets the rest of the death benefit.
The use of a collateral assignment makes sure the lender gets paid only what they are due. If the bank had been made the beneficiary, they would've been given the full death benefit, even if some of the loan had already been paid off. They would've been overpaid, and Bob's wife would've been given nothing.
If you are applying for life insurance to secure your own business loan, remember that there is no reason to make the lender the beneficiary. Use a collateral assignment and make sure your broker walks you through its execution.
Please feel free to contact me with additional questions.