A person or entity has an insurable interest in something if loss or damage to it would cause that person a financial loss or an increase in liability exposure. As a building owner you have an insurable interest in the building(s) you own because in the event of loss or damage to the property you will incur a financial loss to replace or rebuild what has been destroyed. However, others may also have an insurable interest in your property.
If you have a mortgage or other type of financing (hard money, seller carry) on the property, the lender will also have an insurable interest. Banks will loan a percentage of the building’s value, the mortgage will be underwritten by the building’s income, and a property insurance policy will cover the building against loss or damage as well as rental income interruption. In the event of a covered cause of loss, your property policy will pay for the loss of rents and pay to repair or replace the property. In this case, both you and the bank have an insurable interest in the property because a loss or damage to the property will cause a financial loss to both you and the bank.
In this case, does the insurable interest of the bank equal the owner’s insurable interest in the property? Many times the answer is no. In the past, banks have required a policy limit equal to the loan value or the replacement cost of the property, whichever is less. The limits of insurance could be just enough to cover your loan value, but not enough to rebuild or replace your property. This requirement is not very desirable from your point of view because you could be underinsuring your property while only satisfying the insurable interest of the bank.
In today’s market, most of the hazard requirements issued by banks require limits of insurance equal to the loan value or the replacement cost of the property, whichever is greater. Therefore, if your loan value is less than your building’s replacement cost, you will be required to insure your property with enough coverage to rebuild or replace it. Now, both insurable interests are aligned as you will have sufficient coverage to replace or rebuild the building(s) in the event of loss or damage, and the bank will have coverage to ensure you will be able to replace the income producing asset or pay off the mortgage. This is a win/win situation for all parties who have an insurable interest in the property.
If you have any questions about your insurable interest or required coverage, please contact either your insurance carrier or me personally.