Post by Daniel Schwarcz on Jul 13, 2011 10:43:03 GMT 4
Homeowners Insurance Claims and the Foreclosure Crisis
Prompted by several comments to one of my earlier posts, I've been thinking about situations where a homeowner files an insurance claim for property damage to her home while she is in default on her mortgage. The general practice, as I understand it, is for insurers to write claim settlement checks out to the mortgagee, rather than the policyholder, in such situations. This practice is based on a clause in most homeowners policies that "If a mortgagee is named in this policy, any loss payable under Coverage A or B will be paid to the mortgagee and you, as interests appear."
All of this makes sense. But, it seems to me that the mortgagee ought to have an obligation to promptly use any insurance proceeds it receives in this manner to fix the underlying property damage. Failing to do so, and holding on to the insurance proceeds as cash collateral, seems to me to potentially constitute a violation of the mortgagee's obligation of good faith. Yet according to the commentators referenced above, this is apparently a common practice (though I would be curious about other readers' experiences).
Here is why it seems to me that mortgagees should be obliged to use insurance proceeds to promptly pay for the underlying insured damage to the home. Insurance payments for damage to a dwelling are generally meant to restore the underlying property to its undamaged state, or at least to a reasonably usable state (when the policy provides ACV loss settlement). This produces two benefits: it ensures that the value of the property is not substantially diminished and it ensures that the present occupants of the home can promptly use that home as they did prior to the damage.
The first of these benefits -- preserving the value of the home -- protects both the mortgagee and, to the extent the homeowner has some equity in the home, the homeowner as well. From this perspective, it may be reasonable for mortgagees to hold on to the insurance proceeds as cash collateral, and only disburse proceeds if there is surplus after the loan is settled.
But the second benefit of insurance -- preserving the capacity of present occupants to use the home as they had prior to a loss -- is solely for the benefit of the mortgagor/policyholder. And so long as the mortgagee does not have the right to immediately deprive the homeowner of possession, this benefit is both real and potentially valuable. All this means that when a mortgagee refuses to use insurance proceeds to promptly fix the underlying property, it is depriving the homeowner of the second, use-related, benefit of insurance.
If all of this is right, then maybe insurers should not, in fact, pay claims proceeds to mortgagees when the mortgagor is in default, but they should instead directly pay for the underlying home to be fixed. This would not only protect the mortgagee's collateral, but it would also protect the policyholder's right to benefit from her insurance through the prompt restoration of her property.
Prompted by several comments to one of my earlier posts, I've been thinking about situations where a homeowner files an insurance claim for property damage to her home while she is in default on her mortgage. The general practice, as I understand it, is for insurers to write claim settlement checks out to the mortgagee, rather than the policyholder, in such situations. This practice is based on a clause in most homeowners policies that "If a mortgagee is named in this policy, any loss payable under Coverage A or B will be paid to the mortgagee and you, as interests appear."
All of this makes sense. But, it seems to me that the mortgagee ought to have an obligation to promptly use any insurance proceeds it receives in this manner to fix the underlying property damage. Failing to do so, and holding on to the insurance proceeds as cash collateral, seems to me to potentially constitute a violation of the mortgagee's obligation of good faith. Yet according to the commentators referenced above, this is apparently a common practice (though I would be curious about other readers' experiences).
Here is why it seems to me that mortgagees should be obliged to use insurance proceeds to promptly pay for the underlying insured damage to the home. Insurance payments for damage to a dwelling are generally meant to restore the underlying property to its undamaged state, or at least to a reasonably usable state (when the policy provides ACV loss settlement). This produces two benefits: it ensures that the value of the property is not substantially diminished and it ensures that the present occupants of the home can promptly use that home as they did prior to the damage.
The first of these benefits -- preserving the value of the home -- protects both the mortgagee and, to the extent the homeowner has some equity in the home, the homeowner as well. From this perspective, it may be reasonable for mortgagees to hold on to the insurance proceeds as cash collateral, and only disburse proceeds if there is surplus after the loan is settled.
But the second benefit of insurance -- preserving the capacity of present occupants to use the home as they had prior to a loss -- is solely for the benefit of the mortgagor/policyholder. And so long as the mortgagee does not have the right to immediately deprive the homeowner of possession, this benefit is both real and potentially valuable. All this means that when a mortgagee refuses to use insurance proceeds to promptly fix the underlying property, it is depriving the homeowner of the second, use-related, benefit of insurance.
If all of this is right, then maybe insurers should not, in fact, pay claims proceeds to mortgagees when the mortgagor is in default, but they should instead directly pay for the underlying home to be fixed. This would not only protect the mortgagee's collateral, but it would also protect the policyholder's right to benefit from her insurance through the prompt restoration of her property.