SBA Digest: Insurance Requirements – Breaking Down the Basics

The Small Business Administration ("SBA") requires lenders to obtain hazard insurance on any real or personal property collateral securing a loan. In addition to hazard insurance, most lenders also require proof of general liability insurance, worker's compensation insurance, and various other types of coverage depending on the specifics of the transaction. When originating a loan, lenders should carefully evaluate the business to determine what types of insurance should be required to minimize risk. This article outlines some of the most common types of insurance and discusses specific requirements, as set forth in Standard Operating Procedures 50 10 5 (I).

Real Estate: If a loan is secured by real property, the lender should request proof of real estate insurance on a signed Acord 27 or 28. The insurance must be on all real properties pledged as collateral in the amount of full replacement cost. If full replacement cost is not available, coverage must be for the maximum insurable value. Additionally, the insurance coverage must contain a mortgagee clause in favor of the lender and provide that "any action or failure to act by the mortgagor or owner of the insured property will not invalidate the interest of lender." Finally, the policy or endorsements must provide for at least 10 days' prior written notice to lender of policy cancellation.

Personal Property: If the loan is secured by business assets/personal property, the lender should request proof of property insurance on a signed accord 27 or 28. The insurance must be on the subject location and cover business assets/personal property in the amount of full replacement cost. If full replacement cost is not available, coverage must be for the maximum insurable value. Additionally, the insurance coverage must contain a Lender's Loss Payable Clause in favor of the lender and provide that "any action or failure to act by the debtor or owner of the insured property will not invalidate the interest of the lender." Finally, the policy or endorsements must provide for at least 10 days' prior written notice to lender of policy cancellation.

Flood Insurance: When originating a loan, the lender should order a flood determination on all real estate collateral locations. If any portion of the real estate is located in a flood zone, the borrower must obtain flood insurance for the real estate under the National Flood Insurance Program. Similarly, if any personal property collateral is at the real estate located in a flood zone, the borrower must obtain flood insurance for the personal property. The insurance coverage must be in amounts equal to the lesser of the insurable value of the property or the maximum limit of coverage available. Additionally, the insurance coverage must contain a mortgagee clause for real property and/or a lender's loss payable clause for personal property in favor of the lender and provide that "any action or failure to act by the debtor or owner of the insured property will not invalidate the interests of the lender."

Life Insurance: If the lender is processing a standard SBA 7(a) loan over $350,000.00, it may follow its own internal policy for similarly sized non-SBA guaranteed commercial loans. However, if the loan is not fully secured, life insurance is required in an amount consistent with the size and term of the loan for the principals of sole proprietorships, single member LLCs, or businesses otherwise dependent on the owner remaining an active participant within the business. When determining the amount of life insurance required, the lender may consider the amount and type of collateral available to repay the loan. If the lender determines the principal is uninsurable, it must document written confirmation from a licensed insurer of the same.

Other Insurance: Although the SBA requires hazard insurance on any real or personal property collateral securing a loan, there are other types of insurance that the lender should require as a matter of prudent lending. The SOP states that a lender "must include any other insurance appropriate to the loan. . ." Depending on the transaction, a lender must also obtain:

  • Liability Insurance;
  • Product Liability Insurance;
  • Dram Shop/Host Liquor Liability Insurance;
  • Malpractice Insurance;
  • Disability Insurance;
  • Workers' Compensation Insurance; and
  • Any State Specific Insurance Requirements.

The insurance requirements are sometimes difficult to obtain due to the specific language and similar sounding endorsements. For more information on the major impact of minor language differences, see SBA Digest: Lender's Loss Payable vs. Loss Payee. In addition to obtaining sufficient proof of insurance before closing, it is imperative that lenders obtain updated certificates/policies when servicing the loan to prevent potential lapses in coverage and possible repair/denial issues in the future.

For more information about SBA insurance requirements or for other commercial lending matters, please contact one of our experienced commercial lending attorneys:

Chris Poling: cpoling@lewis-kappes.com

Kevin Morrissey: kmorrissey@lewis-kappes.com

Scott Oliver: soliver@lewis-kappes.com