Property insurance not only protects loan collateral, it provides unique insight into underlying geographic, property, and borrower risk.

The availability of insurance and its cost can significantly impact the overall risk of financing an investment property, especially in regions prone to natural disasters or with complicated claims histories. By evaluating geographic and property-specific risks, understanding what to look for on loss run reports, and ensuring borrowers meet policy requirements, you can make informed decisions to protect your interests in investment properties.

Let’s explore the key factors that influence real estate investment insurance and how they can guide your lending strategies.

Geographic and Weather Considerations

Considering regional risks is crucial when insuring investment properties. Both the high frequency of claims and the severity of claims directly affect the risk profile of a property and its associated insurance costs. Some regions, particularly those susceptible to natural disasters like hurricanes, wind/hail, and wildfires, have seen higher loss ratios, which can lead to increased insurance premiums and reduced coverage options. Understanding these risks can help you anticipate insurance challenges and assess potential loans.

In recent years, extreme weather events across the country have raised awareness about the increased risks to residential properties. Winter storms, tornadoes, hailstorms, wildfires, and hurricanes all contribute to the increased costs of property insurance we’ve observed in recent years. 

Many insurance carriers have pulled out of high-risk areas in recent years due to the escalating frequency and severity of claims. This withdrawal has led to limited options for investment property owners and increased the cost of coverage. Properties located in areas with a stable insurance market may be a better fit for some lenders’ books of business because these areas are likely to have more access to affordable coverage and less volatility in the insurance landscape. However, some lenders may still consider financing properties in high-risk areas if the potential returns justify the increased insurance costs and inherent risks, especially if the borrower demonstrates a strong track record of owning similar properties.

Property-Specific Risks and Liability Concerns

Beyond geographic considerations, the condition of the property itself plays a vital role in assessing risk.

Factors such as the type of wiring used and potential liability issues can significantly affect insurance availability and costs.  Older properties, especially those with outdated wiring systems like aluminum or knob and tube wiring, present fire hazards that insurers are increasingly unwilling to cover.

As a lender, it’s crucial to consider the condition of the property as well as its systems. Properties that have not been maintained well or upgraded in many years may face higher insurance costs, limited coverage options, and increased potential for loss. However, if an older property has undergone renovations to modernize its wiring and infrastructure, it can mitigate some of these risks, making insurance more accessible and loaning on the property less risky.

Liability issues extend beyond the property’s structure and condition. Properties in areas with higher rates of bodily injury claims (e.g., slip-and-fall incidents) can present significant challenges. Multifamily buildings or properties that have shared spaces such as lobbies and common areas may pose elevated risks for these accidents.

Further, some areas of the country have complex tenant-landlord laws that contribute to frequent lease disputes, increasing the potential for claims and litigation. These factors can drive up insurance costs and increase the likelihood of issues occurring at a property in the area. Lenders must carefully evaluate properties located in jurisdictions known for litigious environments.

Borrower and Property Loss Runs

Due diligence is a crucial aspect of any business transaction, especially when assessing potential borrowers and the properties they wish to finance. Knowing a property’s claims history and a borrower’s insurance background can provide insight into the risks you would be taking. Requiring potential borrowers to disclose loss information for the past three to five years is considered standard practice and can be highly informative. There are two main types of reports you can request: the C.L.U.E. report and the loss run report.

C.L.U.E. report is a Comprehensive Loss Underwriting Exchange (C.L.U.E.) report offers a detailed history of prior insurance claims associated with a specific property or an individual. For around $12, lenders can obtain the report, which outlines the types of claims filed and any applicable total payouts.

A C.L.U.E. report provides information on claims made at a specific property, regardless of the owner, over the last seven years. This is especially useful because it can reveal issues that might lead to ongoing problems for your borrower.

A C.L.U.E. report can also detail an individual’s personal claims history over the past five to seven years. This can provide you with insight into a potential borrower’s track record with property management and potential risk factors.

Note: Privacy regulations require that individuals can only request their own C.L.U.E. report. This means that if you need a report on a potential borrower’s claims history, they must be directly involved in the request process. Similarly, if you wish to obtain a C.L.U.E. report for a property, the current property owner (the seller) must request it. This ensures compliance with privacy laws while also giving you access to critical information needed for your evaluation.

Loss Run Report. If your potential borrower is purchasing the property from another real estate investor, the borrower will need to ask the seller to provide a loss run report from their insurance carrier. This report may take a few days to obtain, and it contains the same loss information as a C.L.U.E. report.

You must be vigilant about reviewing these reports, paying particular attention to the frequency and severity of claims. Multiple minor claims or a single catastrophic event can signal increased risk. Additionally, if a potential borrower has incurred multiple controllable losses, such as those resulting from neglect or poor maintenance, that may be a more significant red flag than unpreventable, weather-related incidents. Recognizing these patterns will help you make informed lending decisions.

If a property has a history of claims, but it’s still a good fit for you as a lender, you may consider suggesting certain mitigation strategies. You can offer educational resources to the borrower that provide information on property maintenance and risk management for specific perils. For example, if a property has a history of water damage, you may recommend the borrower invest in water monitoring systems such as smart sump pumps or leak detectors. This approach empowers borrowers to increase the insurability of the property while also reducing the likelihood of future claims.     

Insurance Policy Requirements

When financing investment properties, it’s vital to ensure that your borrowers adhere to specific insurance requirements to protect their investment and your stake in the property.

Ensuring borrowers maintain appropriate coverage amounts is essential for minimizing risk. Regardless of the property type or occupancy status, always require the borrower to carry insurance coverage that meets or exceeds the outstanding loan amount. The loan value must be the minimum of what the property is insured for. If the loan value is $150,000, under no circumstances should you allow the borrower to insure at any amount less than $150,000.

Your position as a lender needs to be secure within the borrower’s insurance policy through specific designations, including:

Mortgagee. Having yourself listed as the “mortgagee” ensures you are notified of any policy changes, nonrenewals, or cancellations.

Loss payee. This designation guarantees you are named on any insurance payout resulting from property damage or loss. This inclusion helps direct funds appropriately in case of a claim.

Additional insured (AI). Requiring that you be listed as an “AI” helps provide an extra layer of protection, shielding you from liability claims related to the property.

As insurance and lending markets continue to evolve, staying proactive in your assessment strategies is vital. Maintaining knowledge of geographic and property-specific risks, leveraging tools like C.L.U.E. reports, and implementing comprehensive insurance policy requirements can help mitigate risks associated with financing investment properties. These practices not only help protect your financial interests but also contribute to more secure, well-informed lending.