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Property insurance plays a critical role in the efficient operation of the real estate finance industry and there are severe challenges faced by our industry when there is a lack of insurance information transparency. In a typical commercial mortgage, the lender finances at least 80% of the property value, leaving the borrower with less than 20% equity in the property. The loans are almost always non-recourse. Therefore, the lender has the greatest financial risk in any loan transaction and has an insurable interest.

As part of the loan transaction, the borrower agrees in the contracts to obtain insurance that meets the lender’s requirements, to provide the lender with proof of coverage and to notify the lender of any policy cancellation. When the borrower works with its insurance agent, the insurance requirements should be communicated and adhered to in the policy. The lender will not close a loan without the proper insurance in place.

For more than 30 years the real estate industry has relied on forms like Acord 28 to provide proof of the property insurance coverage. The insurance certificate offers reliance to both the lender and the borrower that insurance is in place and will be in place for a defined period of time. It is also important to note that it is not the intention of the lender (at closing) or the servicer (at annual renewal) to expand the use of an insurance certificate or Acord beyond its customary use or the actual policy terms. In fact, the lender and servicer want the certificate to accurately reflect the policy terms for assurance that the borrower has met its contract obligations. The servicers address policy gaps, cancellations and/or inadequate coverage with the borrower when they become aware of the policy terms. In extreme cases, this can include force-placing insurance–very expensive for the borrower–and actually throwing the loan into default.

The lack of reliable insurance information is also harmful to the borrower. Without insurance information transparency, the servicer cannot verify the insurance contractual terms to ensure the borrower is in compliance. Without proof of valid and enforceable insurance coverage, the borrower is in contractual default which, again leads to increased borrower costs, potential litigation and potential loss of the property.

Acord 28 is a natural evolution of the Acord 27 form. As loan transactions have become increasingly larger in size and complexity, regulators and investors have placed increasing importance on more information transparency. Events like Sept. 11, and more recently Hurricane Katrina, place a bright spotlight on insurance coverage. The real estate industry must have more specific insurance information in a timely manner.

Recent changes to the Acord 28 form introduced new disclaimers that specifically state that the forms are for information only and, therefore, threaten the forms’ use as adequate proof of insurance and render the forms useless for their intended purpose. The lender and servicer can no longer rely on the certificate. Thus, the borrower has not fulfilled its contractual obligation to provide proof of valid and enforceable coverage.

In addition, changes to the Acord forms no longer obligate insurers to notify named parties of insurance cancellations. These changes create significant contractual and legal compliance burdens regarding collateral protection. The language provided on Acord 28 no longer mirror the actual language provided in the policy, thereby introducing new confusion and inconsistency into the market and harming the goal of insurance information transparency.

Organizations such as Freddie Mac issued a press release indicating that they would no longer accept the revised versions of Acord 28. In addition, many commercial real estate lenders and rating agencies have rejected the revised Acord 28 form. The changes on the Acord 28 form have also had a negative impact on the commercial mortgage-backed securities industry. The CMBS industry has grown dramatically to where it now accounts for 20% of all commercial mortgage debt outstanding. Serving an important role in the CMBS industry are the rating agencies who may look negatively on mortgage pools that include a high percentage of mortgages with the revised Acord 28 form in their documentation.

This has had a dramatic impact on commercial real estate lenders. Many lendersoriginate commercial real estate loans with the intent to either securitize the loanthemselves or sell these loans to companies that issue CMBS. These lenders typicallyoriginate and sell or securitize their commercial mortgages within 30 to 90 days ofissuing the mortgages. This allows them to free up capital to lend on other commercialreal estate projects. However, when lenders are not able to sell or securitize theirinventory of commercial mortgages because of rating agency concerns about mortgages with the revised Acord form, these lenders are forced to keep these loans on their books. This prevents lenders from making new loans because their capital assets are tied up in mortgages that they cannot securitize.

Ironically, this is also a problem for the insurance industry. On the investmentside of the business, insurance companies make commercial real estate loans, aswell as issue and purchase CMBS. In fact, insurance companies currently hold$271 billion in commercial/multifamily mortgages. Consequently, activitiesthat undermine the commercial mortgage and CMBS markets also undermine theinvestments of insurance companies.

Given that the real estate finance and insurance industries both serve thesame customer, the borrower, MBA has been reaching out to important insuranceindustry stakeholders, which include the National Association of Insurance Commissioners (NAIC) and Acord, to craft a solution to the insurance information transparency problem. MBA is seeking a long-term permanent solution to the real estate finance industry’s request for insurance information transparency. A resolution to the Acord 28 discussion is one, important step in achieving this goal.

Deborah O. McKinnon is the vice president, commercial/multifamily at the Mortgage Bankers Association. The views expressed in this article are the author’s own.

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