Have you ever taken the time to read the language of an owner's policy jacket? If you are like most attorneys I know, you have little time to read the title commitment for a closing let alone the dry, dull and technical language of a policy jacket. You may even think that all owner's policies are basically alike. Think again.
The ALTA 1992 Owner's Policy of Title Insurance is also called a "Coinsurance Contract" because this particular policy, unlike other owner's policies, contains a little known provision called the 'coinsurance provision". The coinsurance provision limits coverage to an owner when they obtain title insurance in an amount less than the fair market value of the insured property. The main purpose behind the coinsurance provision is to prevent a title insurer from bearing 100% of a partial loss if the value of property increases due to substantial post-policy improvements. Thus, in order for attorneys to best serve their clients, it is important that they be aware of exactly which type of policy they request on behalf of a client and, additionally, to understand exactly what the policy coverage entails.
Two Ways to Trigger the Coinsurance Provision
There are two (2) instances where an owner can become a coinsurer with the title insurance company under his policy: (1) where the owner makes subsequent improvements to the property after purchasing an owner's policy; and (2) where there are no subsequent improvements made, but the owner underinsures himself by more than twenty percent (20%). In both of these instances, there is leeway built in of 20%. Therefore, if subsequent improvements are made to the property but they do not increase the fair market value by more than 20% of the policy amount, the coinsurance provision will not be triggered. In the alternative, if the fair market value at the time the policy is issued does not exceed the policy amount by more than 20 %, the coinsurance provision will not be triggered. Once triggered, the coinsurance provision provides that the title insurance company will only pay a pro rata portion of the loss suffered by an owner.
Assume that a Client requests his Attorney to conduct the closing when Client purchases a vacant residential lot. Client is purchasing the lot for $50,000.00 (fair market value) and intends to obtain construction financing to build his dream home on the property. At the time Client acquires the lot, Attorney advises Client that he should get an owner's policy of title insurance in the amount of the purchase price to protect Client's investment. Attorney requests from the title insurance company an owner's policy in the amount of $50,000.00 and a lender's policy in the amount of $125,000.00, the amount of the construction loan. Upon completion of the improvements to the property nine months later, Client obtains permanent financing in the amount of $150,000.00. Lender requires a new lender's policy in the amount of $150,000.00 but Client does not get a new owner's policy at that time, even though the current fair market value of the property with improvements is now $200,000.00.
Two years later, Client discovers that there is a lien on his property in the amount of $100,000.00 which was not mentioned in his title policy. Client files a claim under his owner's policy.
By not having obtained a new owner's policy for the increased fair market value of the property following the improvements, Client under-insured himself. Consequently, if Client received a traditional ALTA 1992 Owner's policy, Client will now be liable as a coinsurer under his policy as a result of the coinsurance provision. Because this loss is considered a partial loss exceeding 10% of the policy amount, the coinsurance provision comes into play. Under the formula contained in the provision, the title insurance company will only pay 30% of Client's loss or $30,000.00 out of the $100,000.00 lien. Likewise, if there were a total loss or failure of title, the coinsurance provision would not apply, but the title insurance company would only be liable for the face amount of the policy, or $50,000.00. Either way, Client is obligated to pay the remaining amount required to satisfy the lien.
Most likely, these results were not intended by either Attorney or Client. While it is by no means certain that Attorney would be liable for failing to advise Client to get a new owner's policy (assuming it was not Attorney's error in failing to report the lien), it would behoove Attorney to have documentation in his file showing that he offered Client such advice and Client declined to get the additional insurance.
By recognizing such issues and understanding the nature of the title insurance coverage requested, attorneys will be better able to educate their clients and potentially avoid unfortunate consequences such as those mentioned above.