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SBA 504 Q&A: Insurance Requirements

Nov 2021

Q: What are the Small Business Administration's (SBA) requirements regarding insurance pertaining to a 504 loan project?

A: The SBA requires insurance on ALL assets pledged as collateral. The borrower must also maintain a separate policy if the business is located in a state that requires additional coverage(s) such as wind, hail, earthquake or other.

1) Hazard Insurance

a. Real Estate:

(1) Coverage must be in the amount of the full replacement cost.

(2) If full replacement cost insurance is not available, coverage must be for the maximum insurable value.

(3) Insurance coverage must contain a MORTGAGEE CLAUSE (or substantial equivalent) in favor of the Certified Development Company (CDC)/SBA. This clause must provide that any action or failure to act by the mortgagor or owner of the insured property will not invalidate the interest of the CDC/SBA. The policy or endorsements must provide for at least 10 days prior written notice to the CDC/SBA of policy cancellation.

NOTE: A copy of the policy must be provided to the CDC/SBA.

b. Personal Property:

(1) Coverage must be in the amount of full replacement cost.

(2) If full replacement cost insurance is not available, coverage must be for maximum insurable value.

(3) Insurance coverage must contain a LENDER'S LOSS PAYABLE CLAUSE in favor of the CDC/SBA. This clause must provide that any action or failure to act by the debtor or owner of the insured property will not invalidate the interest of the CDC/SBA. The policy or endorsements must provide for at least 10 days prior written notice to the CDC/SBA of policy cancellation.

NOTE: A copy of the policy must be provided to the CDC/SBA.

2) Marine Insurance

a) Coverage in the amount of the full insurable value on the vessel(s) with the CDC/SBA designated as "mortgagee" must be obtained when the vessel is the collateral on the loan.

b) The policy must contain a mortgagee clause providing that the interest of the CDC/SBA will not be invalidated by any:

a. Act, omission, or negligence of the mortgagor, owner, master, agent or crew of the insured vessel;

b. Failure to comply with any warranty or condition out of mortgagee's control; or

c. Change in title, ownership, or management of the vessel.

c) The policy must include protection and indemnity, breach of warranty, and pollution coverage.

d) The policy or endorsements must provide for at least 10 days prior written notice to the CDC/SBA of policy cancellation.

NOTE: A copy of the policy must be provided to the CDC/SBA.

3) Flood Insurance

a) SBA flood insurance requirements are based on the Standard Flood Hazard Determination (FEMA Form 086-0-32 or its successor). The mandatory purchase of flood insurance requirements set forth by the National Flood Insurance Program (NFIP) apply with equal force to condominium and cooperative units. Policies for such units will consist of separate policies obtained by the individual unit owner for the particular unit and the condominium or cooperative association for the exterior of the entire building.

b) If any of the following is located in a special flood hazard area, the CDC must require the borrower to obtain flood insurance: any portion of a building that is collateral for the loan; any equipment, fixtures or inventory that is collateral for the loan that may be located in a building any portion of which is located in a special flood hazard area; personal property collateral in a building any portion of which may be located in a special flood hazard area, even if the building itself is no project collateral.

c) Insurance coverage must be at least equal to the outstanding principal balance of the loan or the maximum limit of coverage made available under the National Flood Insurance Act of 1968, as amended (42 U.S.C. 4001 et seq.), whichever is less. (“Maximum limit of coverage available” is the lesser of the maximum limit available under the NFIP for the type of structure of the insurable vale of the structure).

d) Insurance coverage must contain a MORTGAGEE CLAUSE/LENDER'S LOSS PAYABLE CLAUSE (or substantial equivalent) in favor of the CDC/SBA. This clause must provide that any action or failure to act by the debtor or owner of the insured property will not invalidate the interest of the CDC/SBA.

e) Private flood insurance is acceptable provided it meets the same requirements as the standard NFIP policy. If private insurance is used, the following conditions must be met:

i. It must provide coverage that is at least as broad as the coverage provided under the standard NFIP policy, including when considering deductibles, exclusions, and conditions offered by the insurer;

ii. It must include an endorsement that insurer must give 45 days’ notice of cancellation for non-renewal to the insured and the CDC/SBA;

iii. It must include information about the availability of flood insurance coverage under the NFIP;

iv. It must contain a mortgage interest clause similar to the one in the standard NFIP policy;

v. It must contain a provision requiring an insured to file suit not later than 1 year after date of a written denial of all nor part of a claim under the policy; and

vi. It must contain cancellation provisions that are as restrictive as the provisions contained in the standard NFIP policy.

NOTE: A copy of the policy must be provided to the CDC/SBA

4) Life Insurance

a) The CDC must determine if the viability of the business is tied to an individual or individuals. Life insurance is required for the principals of sole proprietorships, single member LLCs, or for businesses otherwise dependent on one owner’s active participation when the SBA 504 loan is not fully collateralized.

b) Life insurance required must be consistent with the size and term of the loan. In general, for a 10-year debenture, the minimum term would be 10 years; and for a 20- or 25-year debenture, the minimum term would be 20 years. The amount and type of collateral available to repay the loan in the event of the death of the borrower may be factored into the determination of the appropriate amount of life insurance.

c) For each policy required under this paragraph, the CDC must obtain a collateral assignment, identifying the CDC/SBA as assignee that is acknowledged by the home office of the insurer. The CDC must assure that the borrower pays the premiums on the policy.

d) The CDC may accept the pledge of an existing life insurance policy.

NOTE: A copy of the insurance policy must be provided to the CDC/SBA.

5) Other Insurance

The CDC must include any other insurance appropriate to the loan, including but not limited to:

1. Liability insurance;

2. Product liability insurance;

3. Dram shop/host liquor liability insurance;

4. Malpractice insurance;

5. Disability insurance;

6. Worker's compensation insurance; and

7. Any state specific insurance requirements.

All required insurance coverage must be obtained by the borrower prior to 504 Loan closing and coverage must be maintained for the life of the loan.

If you have a question for our SBA 504 loan experts, email us at info@ffcfc.com.