Massachusetts Agencies

Underinsured Owners

Articles from The Massachusetts Focus

Newsletter of Stewart Title Guaranty Company, Massachusetts Offices
Spring 2005, Volume 4, Number 2

Underinsured Owners
by Richard Urban, Vice President and Massachusetts State Counsel

We have recently experienced an increase in underwriting and policy preparation questions arising from sales involving construction loans and the amount of insurance which should be made available to the buyer for an owner’s policy of title insurance.

In these scenarios, the agent should recognize the ramifications of "underinsuring" owners that are best illustrated by the following examples.

Example No. 1: Total loss of title.

Owner purchases an unimproved lot for $50,000 and simultaneously obtains a construction loan for $150,000.

Lender is insured for $150,000.

Owner is insured for $50,000.

"Anticipated value" of the property, after construction, is $250,000.

A successful claim on the insured premises is made which involves a total loss of title that affects both the insured lender and insured owner.

Paragraph 11 of the Conditions and Stipulations of an ALTA 1992 owner's policy which is entitled “Liability Noncumulative” specifically states that:

... the amount of the insurance under this policy shall be reduced by any amount the Company may pay under any policy insuring a mortgage to which exception is taken in Schedule B or to which the insured has agreed, assumed, or taken subject, or which is hereafter executed by an insured and which is a charge or a lien on the estate or interest described or referred to in Schedule A, and the amount so paid shall be deemed a payment under this policy to the insured owner.

Because of this provision, the insured lender, in our example, will be paid up to $150,000, depending upon the amount of the lender's mortgage which is outstanding at the time of the loss. Pursuant to this provision, the payment to the insured lender will be deemed a payment to the insured owner. Consequently, the payment will deplete the amount of insurance available to the insured owner and leave the owner with no insurance available for the balance of any loss that is suffered. 

Example No. 2: Partial loss of title.

Owner purchases unimproved lot for $50,000 and simultaneously obtains a construction loan for $150,000.

Lender is insured for $150,000.

Owner is insured for $50,000.

"Anticipated value" of the lot, after improvements, is $250,000. Owner attempts to sell the lot, after the construction is completed, and discovers an outstanding attachment, which pre-dates the policy, in the amount of $10,000 and the owner files a claim.

Paragraph 7(b) of the Conditions and Stipulations of an ALTA 1992 owner's policy is the appropriate provision under which the title insurance company would consider the claim. The first part of this paragraph sets forth the qualifying criteria that must be met in order to trigger its proportionate damages provision. It states that:

In the event that the amount of the insurance stated in Schedule A at the date of the policy is less than 80 percent of the value of the insured estate or interest or the full consideration paid for the land, whichever is less, or if subsequent to the date of Policy an improvement is erected on the land which increases the value of the improved estate by at least 20 percent over the amount of insurance stated in Schedule A, then this policy is subject to the following...

If this qualification is met, then paragraph 7(b)(ii) will be used to determine how much of the insured owner's claim the company will pay. The formula is set forth as follows:

Where a subsequent improvement has been made, as to any partial loss, the company shall only pay the loss pro rata in the proportion that 120 percent of the amount of insurance stated in Schedule A bears to the sum of the amount of insurance stated in Schedule A and the amount extended for the improvement.

An application of the first part of paragraph 7(b) to our example discloses that it readily satisfies the qualifying criteria, i.e., subsequent to the date of the policy, improvements were erected on the land, which increased the value of the insured estate by at least 20 percent over the amount of the original insurance.

An application of the proportionate damages formula in paragraph 7(b)(ii) to this example would be calculated as follows:

$50,000 (Owner's amount of insurance) x 120% = $60,000.

$50,000.00 (Owner's amount of insurance) + $150,000. (Amount extended for the improvement) = 200,000.

Pro rata computation: $60,000.00 divided by $200,000 = 30%.

The title insurance company would be obligated to pay 30% of the $10,000 attachment, or $3,000.

This section of the owner's policy is intended to minimize the unfair results a title insurance company could incur in situations whereby insured owners purchase amounts of title insurance which do not take into account the anticipated value of improvements and whereby title insurance companies receive premiums based on an amount less than the property's worth.

To avoid this unpleasant possibility from arising, the owner should be advised that he may be underinsured and that he may be able to insure the property for the "anticipated value” of the property.

An “anticipated value” can usually be determined from an "as-built" appraisal that most lenders will have required as part of its approval of the construction loan. The appraisal can be used as evidence of the value of the property after the contemplated construction is completed. Consequently, even though vacant land is being acquired, the “anticipated value” of the property can be the amount of insurance for an owner’s policy and such a policy can be issued in conventional, simultaneous fashion along with the loan policy at time of purchase subject to a “Pending Improvements Clause” in the owner’s policy, as follows:

Liability under this policy is presently limited to the purchase price of the land and will increase to, and include, the actual value of improvements erected in good faith and fully paid for. Liability, however, shall not exceed the amount of insurance stated in the policy

If the “anticipated value” cannot be reasonably determined at the time of purchase or if the insured owner declines to purchase a policy in the amount of the “anticipated value” at time of purchase, the agent may issue an owner's policy in the amount of the original purchase price of the vacant land. You may want to advise the insured of the availability of insurance in the amount of the anticipated value of the insured premises after improvements have been constructed, and note in your file that the insured elected to request insurance only in the amount shown on Schedule A.

As an alternative to issuing an owner’s policy in the amount of “anticipated value,” once the improvements are completed, an endorsement to the policy may be issued to increase the amount of insurance to the full value of the property. However, an additional premium will be due and will be charged at regular rates for the increased amount of insurance. It is important to note that if the policy had been originally issued in the amount of the “anticipated value,” as described above, the owner could have taken advantage of the lower premiums associated with the simultaneous issuance of lender's and owner's policies and would have saved some cost.