Leasing Practice

Step 6 Insurance

This step – the conclusion of insurance under the lease, as part of the leasing practice, should be performed jointly by the lessor and the lessee. Indeed, lessees often incorrectly underestimate their participation in the ensuring the insurance coverage.

Normally, the leasing asset is the primary collateral for each leasing transaction. This means that if the lessee is unable or unwilling to continue to service his obligations under the lease, the lessor reposesses the leasing asset. Subsequently, the lessor sells the repossessed asset on the secondary market and, with the proceeds, satisfies his remaining receivables under the lease. Often (in the case of leasing for production equipment), the leasing asset is also the generator of revenue, which is used partly to pay the leasing obligations. What would happen if the leasing asset suffered damage or disappeared?

All lease deals provide for the conclusion of one or more insurance policies. Insurances are necessary to cover various risks associated with the leasing transaction. Some of them are present in each leasing transaction – for example, damage to the leased asset. Others are slightly more specific and are used only occasionally – for example, the Lessee’s life insurance.

leasing asset risk mitigation

If the leasing asset is the primary collateral for each leasing transaction, it is quite obvious that its damage or total loss would greatly confuse the relationship between the lessor and the lessee. That is why most leasing deals provide for the full insurance of the leased asset covering all possible risks. For example, when leasing a car, such insurance will be ful “Auto CASCO” concluded with a “reputable insurance company”.

Upon occurrence of an insurance event – damage, theft or total loss, the insurance company pays insurance indemnity to the lessor (as owner of the asset). The lessor deducts remaining claims under the lease and refunds to the lessee the remaining amount. It is also possible, using the insurance indemnity, to purchase a new leasing asset and the entry of both parties into a new lease contract.

Accordingly, each leasing agreement (or its “General Conditions”) has an extensive section which determines as a liability of the lessee to take out such insurance and maintain it for the entire term of the contract. The rights of both parties are also regulated if an insurance event should occur.

Although the conclusion of insurance is the responsibility of the lessee, most lessors have a relationship with one or several “reputable insurance companies” and take out the policies in the name and on behalf of the lessee with them. This is not a bad practice because, due to the large amount of insurances coming from a lessor, insurers often provide discounts from their standard rates that would not be possible for single insurances.

It is important to note that, although the leasing asset insurance reduces / or fully eliminates / risks for the asset, the leasing contract does not negate the lessee’s liability to protect the leased asset, and in most cases even provides for “full payment of all remaining lease payments” by the lessee in the event of loss or disappearance of the leasing asset. The leasing asset insurance makes this more feasible.

As the lessee bears full responsibility for his leased asset, the insurance relieves (in part) this liability. Accordingly, despite the practice of most lessors in Bulgaria to take out insurances on behalf of the lessees, the lessee himself should carefully examine the terms of the relevant insurance policy, the reputation of the insurance company, the risks covered and the excluded ones. Should he find any unacceptable clauses, these need to be communicated with the lessor and a way to correct them found.

The property insurance of the leasing asset reduces the risks of the leasing transaction (s) for both parties and increases the costs for the lessee (as long as not everyone would have a property insurance for their own property).

Mitigation of the risks associated with the use of the leasing asset

Assuming that the property insurance covers some risks related with the leasing asset, there is yet another group of risks that are not covered by it. These are risks that arise from the use of the leased asset. Continuing the example with the leasing of a car, this additional group of risks are the ones associated with the risks to other people, cars and property which arise from driving (using) the car – such as road accidents and damage to another vehicles, injured pedestrians, damage to roadside equipment, etc.

The specific thing here is that damages result from the use of the leasing asset by the lessee, but the owner of the asset is the lessor. By default, lessors transfer this responsibility to lessees and seek additional collateral.

The additional collateral in this case is so called “Third Party Liability Insurance”, for cars, or similar insurance cover for different kinds of equipment. This insurance involves the cover of damage (to a certain amount) caused by the leasing asset to third parties.

The insurance cover for the use of the leasing asset reduces the risks of the Lease Agreement (s) for both parties. With cars, it can not be claimed that Third Party Liability insurance increases the costs of the lessee (as the law renders it mandatory for every car – leased or otherwise). At the same time it should be taken into account because it represents another additional cost for the lessee.

Mitigation of risks related to the lessee

Financial risk insurance cover

In addition to collateral enhancement (described in the article “Analysis of the Creditworthiness”), insurance products are also sometimes used as collateral. Such a product is the Financial Risk Insurance.

This insurance provides for the payment of part or all of the remaining liabilities under a leasing contract by the insurance company in the instance that the lessee is unable to meet its financial commitments under the leasing contract. The insurance premium is for the expense of the lessee, and the beneficiary is the lessor, at the time of the occurrence of the insured event.

The “Financial Risk” insurance was popular in Bulgaria prior to the Financial Crisis of 2008 and as can be expected, insurance companies stopped offering it in the years that followed.

„Life Insurance“

Sometimes the analysis of the creditworthiness of a small or medium-sized company shows excellent results and leads to the approval of the lease. At the same time, the firm appears to be entirely dependent on one person – for example, its owner. In short, if this person is well the company will flourish, but if something happens to that person, it is quite possible and the company will stop doing business … and of course seize to service its leasing contract.

To cover this risk, lessors may request the conclusion of life insurance for this specail individual, who is important for the good creditworthiness of the lessee.

In conclusion, we can summarize that “additional collateral” in one form or another accompanies each leasing transaction. It is advisable for lessees to acquaint themselves with each of them in advance, to be aware of the protection provided by the insurance cover, the risks excluded, their specific requirements and, accordingly, to provide for their costs in their “leasing budget”.

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