What Is Force-Placed Insurance And How Do You Avoid It?

There is no law, at either the state or federal level, that requires property owners to get insurance coverage. But most banks and lenders do require it—they won’t front any money unless they’re sure their investment is protected. Despite this requirement, there are still situations where a property owner has a lapse or gap in coverage. When this happens, the mortgage lender or bank will purchase force-placed insurance, also known as “lender placed” or “collateral protection” insurance.

What is force-placed insurance?

Force-placed insurance is a type of coverage that a financial institution can purchase on behalf of a borrower or debtor who fails to maintain adequate coverage on their property. This coverage can be activated for both commercial and residential properties, but for the purposes of this article, we’ll focus on the commercial implications.

For example, let’s say a commercial building owner fails to renew their property insurance policy or underinsures the building. The lender may imposes a force-placed policy to cover the building against perils like fire, theft, or natural disasters.

force-placed policies can also be very specific, such as when a commercial property has significant machinery and equipment that the business owner fails to insure. The lender can obtain force-placed insurance specifically for the machinery to protect its value.

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How Force-Placed Insurance Works

This is the typical scenario where a force-placed insurance would be put in play:

1. Lender Realizes Borrower Has Insufficient Or Lapsed Coverage: If a borrower’s insurance lapses (e.g. due to non-payment of premiums) or the lender determines that the borrower’s insurance coverage is insufficient, the lender will impose a force-placed insurance policy to protect their interest in the property.
2. Lender Notifies Borrower: Before placing the insurance, lenders typically notify the borrower and provide an opportunity to rectify the lapse in coverage or provide evidence of sufficient coverage.
3. Borrower Is Billed: The borrower must pay for the forced-place insurance policy. The cost can be added to the borrower’s loan balance, deducted from the escrow account, or charged as a separate fee.
4. Lender Gains Protection: Even though the borrower is billed for the policy, the lender becomes the named insured. This is because the policy is designed to protect the lender's investment in the property, rather than the borrower’s interest.

Pros And Cons Of Force-Placed Insurance For Businesses

This type of policy has a specific purpose that comes with some benefits, but force-placed insurance is generally lower quality than other policies in the standard market. Here’s a quick summary of the good and bad:

Cons

• Sky-High Costs: Premiums are usually significantly higher (up to 10 times higher) than standard commercial policies.
• Limited Coverage: Coverage typically doesn’t meet the borrower’s needs and has gaps that often exclude personal property, business interruption, and general liability.
• Additional Debt: The cost is often added to the loan balance, increasing the debt load and financial strain on the borrower.

Pros

• Compliance: Gaining coverage allows you to stay compliant with the bank and lets the lender handle the placement of that property.

5 Ways To Avoid Force-Placed Insurance

Property owners are sometimes caught between a rock and a hard place and cannot avoid having the lender implement this policy. But in most cases, these five tactics can help you stay properly insured and keep the lender from stepping in:

1. Know what’s in your loan documents so you are prepared for what the bank will do in a given situation. The loan documents should lay out the process of force-placed insurance.
2. Manage your renewals ahead of time and ensure the coverage aligns with lender requirements. Be sure to update lenders regarding any insurance changes.
3. Have a proper insurance budget. As insurance costs rise, do what you can to pad that budget. 
4. Regularly review and compare insurance policies to avoid underinsurance.
5. Perhaps most importantly, have a good relationship with your insurance agent. You ideally want to work with an agent who specializes in high-hazard Excess and Surplus (E&S) properties. An agent with this expertise can help you handle issues before the lender has to activate force-placed insurance—and if it does get to that point, the agent will help you navigate the situation.

The Bottom Line

In simplest terms, force-placed insurance is very basic coverage that’s designed to protect the financial interests of lenders versus property owners. And generally, it’s not a policy you want on your property.

Our risk advisors have years of experience helping clients find—and keep—the right coverage for their businesses. We can guide you on reviewing and renewing your policies, and work with you to ensure you avoid force-placed insurance. Get a fast, free quote or contact us for more information.