What you Need to Know about Insurance and the SBA Loan April 17, 2014 By Bob Coleman Editor Coleman Report 1
Complimentary Coleman Report Live! Featuring Bob Coleman & Beth Solomon 1:50-2:00 PM E.T. Log on 10 minutes early before every Coleman webinar for a briefing on issues vital to the small business lending industry with your hosts: Bob Coleman, Editor of the Coleman Report Beth Solomon, President & CEO of the National Association of Development Companies (NADCO) 2
Expert Instructors: Robyn McGloin, CFBS McGloin Financial As a life and health insurance agent, Robyn has been involved with small business lending for over 15 years. Her business focuses on expedited life and disability insurance solutions for SBA loan closings and post closing servicing solutions to preserve the SBA guarantee. Casey B. Fernandez Sihle Insurance Group Casey Fernandez is an insurance agent (Agent) located in Altamonte Springs, Florida and specializes in Commercial Insurance, particularly technology risks. Casey provides General, Professional, and Auto Liability, D&O, EPLI as well as Property, Workers Compensation and Health insurance among others. An independent agent, Casey represents dozens of carriers and has clients from Florida to Hawaii and internationally. 3
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What you Need to Know about Insurance and the SBA Loan 1) $350,000 is a Magic Number 2) Prudently Underwriting Insurance Risk 3) Repair Issues in Loan Underwriting 4) Repair Issues in Loan Servicing 6
Top Reasons for SBA 7(a) Guaranty Repair & Denial 1. Lien and Collateral Issues that Result in Missed Recoveries (Generally a Repair) Failure to obtain required lien position Failure to properly perfect security interest Failure to fully collateralize loan at origination when additional collateral was available 7
Top Reasons for SBA 7(a) Guaranty Repair & Denial 2. Unauthorized Use of Proceeds Proceeds disbursed for purpose(s) inconsistent with the loan authorization or subsequent modifications without a business justification. (Could be a Denial if early default and improper use of proceeds caused the failure of the business) Same lender Non SBA loan paid with PLP loan proceeds (preference) 8
Top Reasons for SBA 7(a) Guaranty Repair & Denial 3. Liquidation Deficiencies (Generally a Repair unless harm is the full value of the outstanding balance) Failure to conduct Site Visit which resulted in missed recoveries Improper safeguarding or disposition of collateral which resulted in missed recoveries Misapplication of recoveries to lender s loan when SBA guaranteed loan has lien priority 9
Top Reasons for SBA 7(a) Guaranty Repair & Denial 4. Undocumented Servicing Actions (Generally a Repair) Liens not properly renewed during servicing on worthwhile collateral Release or subordination of collateral without documented business justification Allowing hazard insurance to lapse on major collateral and collateral was subsequently destroyed Failure to maintain life insurance on principal and principal subsequently dies 10
II. INSURANCE REQUIREMENTS (13 CFR 120.160(C)) A. Hazard Insurance 11
Commercial Property Insurance Property insurance covers everything related to the loss and damage of company property due to a wide variety of events such as fire, smoke, wind and hail storms, civil disobedience and vandalism. The definition of "property" is broad, and includes lost income, business interruption, buildings, computers, company papers and money. 12
Commercial Property Insurance Property insurance policies come in two basic forms: (1) all risk policies covering a wide range of incidents and perils except those noted in the policy; (2) peril specific policies that cover losses from only those perils listed in the policy. Examples of peril specific policies include fire, flood, crime and business interruption insurance. All risk policies generally cover risks faced by the average small business, while peril specific policies are usually purchased when there is high risk of peril in a certain area. 13
Commercial Property Insurance 1. SBA requires hazard insurance on all assets pledged as collateral. If the business is located in a state that requires additional coverage such as wind, hail, earthquake or other, on the hazard insurance, the borrower must provide a separate policy. Comment [D105]: Language added for special hazard. 14
Commercial Property Insurance 2. Real Estate: a) Coverage must be in the amount of the full replacement cost. b) If full replacement cost insurance is not available, coverage must be for the maximum insurable value. c) Insurance coverage must contain a MORTGAGEE CLAUSE (or substantial equivalent) in favor of the lender. This clause must provide that any action or failure to act by the mortgagor or owner of the insured property will not invalidate the interest of lender. The policy or endorsements must provide for at least 10 days prior written notice to lender of policy cancellation. 15
Commercial Property Insurance 2. Real Estate: f) Insurance coverage must contain a MORTGAGEE CLAUSE/LENDER'S LOSS PAYABLE CLAUSE (or substantial equivalent) in favor of CDC/SBA. This clause must provide that any action or failure to act by the debtor or owner of the insured property will not invalidate the interest of CDC/SBA. 16
Commercial Property Insurance 3. Personal Property: a) Coverage must be in the amount of full replacement cost. b) If full replacement cost insurance is not available, coverage must be for maximum insurable value. c) Insurance coverage must contain a LENDER'S LOSS PAYABLE CLAUSE in favor of lender. This clause must provide that any action or failure to act by the debtor or owner of the insured property will not invalidate the interest of lender. The policy or endorsements must provide for at least 10 days prior written notice to lender of policy cancellation. 17
Commercial Property Insurance 4. SBA Express, Export Express and Patriot Express: If the lender does not require hazard insurance (for example, if it would impose an undue burden on a borrower given the small size of a loan), the lender must document the reason in its loan file. 18
Marine Insurance 1. Coverage in the amount of the full insurable value on the vessel(s) with lender designated as "Mortgagee" must be obtained when the vessel is the collateral on the loan. 19
Marine Insurance 2. The policy must contain a Mortgagee clause providing that the interest of lender will not be invalidated by any: a) act, omission, or negligence of the mortgagor, owner, master, agent or crew of the insured vessel; b) failure to comply with any warranty or condition out of mortgagee s control; or c) change in title, ownership or management of the vessel. 3. The policy must include Protection and Indemnity, Breach of Warranty, and Pollution coverage. 4. The policy or endorsements must provide for at least 10 days prior written notice to lender of policy cancellation. 20
Flood Insurance 1. SBA flood insurance requirements are based on the Standard Flood Hazard Determination (FEMA Form 086 0 32 or FEMA Form 81 93). Lenders have the option of using either form until May 30, 2015, at which time only FEMA Form 086 0 32 may be used. The mandatory purchase of flood insurance requirements set forth by the National Flood Insurance Program (NFIP) apply with equal force to condominium and cooperative units. Policies for such units will consist of separate policies obtained by the individual unit owner for the particular unit and the condominium or cooperative association for the exterior of the entire building. 21
Flood Insurance 2. If any portion of a building that is collateral for the loan is located in a special flood hazard area, lender must require Borrower to obtain flood insurance for the building under the NFIP. 22
Flood Insurance 3. If any equipment, fixtures or inventory that is collateral for the loan ( Personal Property Collateral ) is in a building any portion of which is located in a special flood hazard area and that building is collateral for the loan, lender must require Borrower to also obtain flood insurance for the Personal Property Collateral under the NFIP. 23
Flood Insurance 4. If any Personal Property Collateral is in a building any portion of which is located in a special flood hazard area and that building is not collateral for the loan, lender must require Borrower to obtain available flood insurance for the Personal Property Collateral. The lender may waive this requirement when the building is not collateral for the loan if it: a) Uses prudent lending standards to determine that flood insurance is not economically feasible or not available; and b) Includes a written justification in the loan file that fully explains why flood insurance is not economically feasible or, if flood insurance is not available, the steps taken to determine that it is not available. 24
Flood Insurance 5. Insurance coverage must be in amounts equal to the lesser of the insurable value of the property or the maximum limit of coverage available. 25
Flood Insurance 6. Insurance coverage must contain a MORTGAGEE CLAUSE/LENDER'S LOSS PAYABLE CLAUSE (or substantial equivalent) in favor of lender. This clause must provide that any action or failure to act by the debtor or owner of the insured property will not invalidate the interest of lender. D. Life Insurance 1. For loans processed under standard 7(a) over $350,000, lenders may follow their internal policy for similarly sized non SBA guaranteed commercial loans, except: If the loan is not fully secured, life insurance 26
Life Insurance For loans processed under standard 7(a) over $350,000, lenders may follow their internal policy for similarly sized non SBA guaranteed commercial loans, except: 27
Life Insurance If the loan is not fully secured, life insurance is required for the principals of sole proprietorships, single member LLCs, or for businesses otherwise dependent on one owner s active participation, consistent with the size and term of the loan. The amount and type of collateral available to repay the loan may be factored into the determination of the appropriate amount of life insurance. 28
Life Insurance If lender determines that the principal is uninsurable, lender must obtain written documentation from a licensed insurer of the same. 29
Life Insurance For loans processed under 7(a) Small Loans, SBA Express and Export Express, lenders may follow their internal policy for similarly sized non SBA guaranteed commercial loans. 30
Life Insurance and the 504 Loan a) CDC must determine if the viability of the business is tied to an individual or individuals. In these situations, the CDC must require life insurance. 31
Life Insurance and the 504 Loan b) Life insurance required must be consistent with the size and term of the loan. The amount and type of collateral available to repay the loan in the event of the death of the borrower may be factored into the determination of the appropriate amount of life insurance. 32
Life Insurance and the 504 Loan c) For each policy required under this paragraph, CDC must obtain a collateral assignment, identifying the CDC/SBA as assignee, that is acknowledged by the Home Office of the Insurer. The CDC must assure that the borrower pays the premiums on the policy. 33
Life Insurance and the 504 Loan d) The CDC may accept the pledge of an existing life insurance policy. When a new policy is required, a decreasing term policy is most appropriate. Credit life insurance or whole life insurance should not be required. 34
Life Insurance for the SBA Loan Understanding the application process: Application Paramed exam Underwriting Approval A binder is not your friend Test Questions the borrower should ask an agent Policy and recorded assignment in 7 10 days Older borrowers seeking life insurance The hard to insure 35
Other Insurance Lender must include any other insurance appropriate to the loan, including but not limited to: 1. Liability Insurance; 36
General Liability Insurance Business owners purchase general liability insurance to cover legal hassles due to accident, injuries and claims of negligence. These policies protect against payments as the result of bodily injury, property damage, medical expenses, libel, slander, the cost of defending lawsuits, and settlement bonds or judgments required during an appeal procedure 37
Product Liability Insurance Companies that manufacture, wholesale, distribute, and retail a product may be liable for its safety. Product liability insurance protects against financial loss as a result of a defect product that causes injury or bodily harm. The amount of insurance you should purchase depends on the products you sell or manufacture. A clothing store would have far less risk than a small appliance store, for example 38
Dram Shop/Host Liquor Liability Insurance 39
Malpractice Insurance 40
Professional Liability Insurance Business owners providing services should consider having professional liability insurance (also known as errors and omissions insurance). This type of liability coverage protects your business against malpractice, errors, and negligence in provision of services to your customers. Depending on your profession, you may be required by your state government to carry such a policy. For example, physicians are required to purchase malpractice insurance as a condition of practicing in certain states. Consult your insurance agent or broker about the type of business property insurance best suited for your small business. 41
Disability Insurance 42
Workers Compensation Insurance 43
Any State specific insurance requirements 44
Home Based Business Insurance Contrary to popular belief, homeowners' insurance policies do not generally cover home based business losses. Depending on risks to your business, you may add riders to your homeowners' policy to cover normal business risks such as property damage. However, homeowners' policies only go so far in covering homebased businesses and you may need to purchase additional policies to cover other risks, such as general and professional liability. 45
Assignment of Lease and Landlord s Waiver If the loan proceeds will finance existing or new improvements on a leasehold interest in land, the underlying ground lease must include, at a minimum, detailed clauses addressing the following: Hazard insurance proceeds resulting from damage to improvements 46
Escrow Policy for Commercial Real Estate Taxes and Insurance When a lender is in a senior lien position on commercial real property financed with an SBA guaranteed loan (or if SBA is in a junior lien position and an escrow account does not exist with the senior lienholder), the borrower and lender may agree to establish an escrow account for the purpose of collecting and paying the real estate taxes, hazard insurance, and flood and earthquake insurance when applicable; 47
SBA Express, Export Express, Patriot Express, and Small Loan Advantage a) Obtain required hazard insurance on all assets taken as collateral, as set forth in Chapter 5, Paragraph II of this Subpart. 48
SBA Express, Export Express, Patriot Express, and Small Loan Advantage b) Make the required flood hazard determination and require flood insurance (when collateral is taken) pursuant to the flood insurance requirements in Chapter 5, Paragraph II of this Subpart. 49
SBA Express, Export Express, Patriot Express, and Small Loan Advantage c) In the construction of a new building or an addition to a building, obtain the borrower's agreement that the construction will conform with the "National Earthquake Hazards Reduction Program Recommended Provisions for the Development of Seismic Regulations for New Buildings" as discussed in Chapter 5, Paragraph VI of this Subpart (Page 192) 50
Environmental Insurance Borrower shall include Lender as a loss payee on all environmental insurance policies held by Borrower relating to the Property. 51
EWCP A discussion of the owners and managers relevant experience in the type of business, including a discussion of any life insurance that will be required; (166) EWCP loans shall be secured by no less than a first lien on all collateral associated with the transactions financed. This includes at least the export inventory and receivables, assignment of credit insurance, letters of credit proceeds, and contract proceeds as applicable. (177) 52
The SBA Environmental Indemnification Agreement Other Factor(s). Lender and SBA may rely on factors other than or in addition to the eight referenced above when considering approval or disbursement. For example, the existence of adequate environmental insurance, bonds, agreements not to sue present and future property owners from the Governmental Entity, Engineering and Institutional Controls, etc. However, reliance solely upon Other Factor(s) requires clearance from the SBA Environmental Committee. This requirement extends to loans processed under PLP, SLA, SBA Express, Export Express and Patriot Express. (183) 53
Typical Insurance Closing/Servicing Issues Assignment of Existing Policies Certain types of insurance are not assignable Timeframe can be lengthy! How to expedite the assignment despite an absentee agent 54
Typical Insurance Closing/Servicing Issues Helping the Borrower Obtain New Insurance Medical screening and other underwriting hoops The Binder Myth Test Questions to ask an agent Older borrowers and the hard to insure 55
Typical Insurance Closing/Servicing Issues Loan Servicing Matters: Preserving the SBA Guaranty Not all insurance companies provide premium overdue notices and lapse notices in all states Options to keep life and disability insurance in force Options when insurance lapses 56
Loan Servicing Matters The Right to Cure and the Lender s Responsibility in Preserving the SBA Guaranty 57
Options to Keep Life Insurance in Force Term Insurance will lapse 31 days after premium is due. If the borrower does not make payment, the lender may make the premium payment to the insurance company within that time period and keep the policy in force. 58
Options to Keep Life Insurance in Force Permanent Insurance (e.g., whole life or universal life) frequently has cash value that can be used to keep the policy in force. 59
Options to Keep Life Insurance in Force Contact the insurance agent or the insurance company s customer service department to inquire about options to use policy dividends and cash value to sustain a permanent policy without making a cash premium payment. 60
Options to Keep Life Insurance in Force An Assignment Questionnaire, sent to the insurance company on a periodic basis, will confirm the status of the policy as of the date the questionnaire is completed. 61
When Life Insurance Premium is Overdue Term life insurance policies generally allow a grace period of 31 days after premium is due, during which the policy remains in force. If premium is not paid by the end of the grace period, the policy will lapse as of the due date. Another 31 days is then generally allowed for prompt reinstatement without requiring evidence of good health. Although a claim would not be paid if the insured dies prior to prompt reinstatement, this window provides a valuable opportunity for the borrower or the lender to step in and keep the policy in force. 62
When Life Insurance Premium is Overdue However, not all insurance companies provide duplicate premium overdue notices and lapse notices to assignees in all states, to inform the lender that the policy is in jeopardy of lapse due to non payment 63
When Life Insurance Lapses Reinstatement requires borrower s cooperation and proof of current good health 64
What you Need to Know about Insurance and the SBA Loan 1) $350,000 is a Magic Number 2) Prudently Underwriting Insurance Risk 3) Repair Issues in Loan Underwriting 4) Repair Issues in Loan Servicing 65
Questions? Bob Coleman Editor, Coleman Report bob@colemanreport.com 66