New York State Seal
STATE OF NEW YORK
INSURANCE DEPARTMENT
25 BEAVER STREET
NEW YORK, NEW YORK 10004

George E. Pataki
Governor

Gregory V. Serio
Superintendent

The Office of General Counsel issued the following opinion on January 8, 2003 , representing the position of the New York State Insurance Department.

Re: Proposed residual value insurance program

Question Presented:

Does the proposed insurance program as described herein constitute residual value insurance and not financial guaranty insurance?

Conclusion:

The proposed program constitutes residual value insurance under New York law.

Facts:

As described in the inquirer’s letter and as clarified in subsequent phone conversations with the inquirer, a property/casualty insurer authorized in New York to write residual value insurance intends to issue an insurance policy as follows: The policy would be issued in connection with proposed transactions whereby a lender, such as a bank, life insurer or other entity, lends money to a special purpose entity ("SPE") for the construction of a commercial retail business structure, typically known as a "big box" store. The SPE will lease the premises to a retailer for a fixed period of twenty years. The loan to the SPE will specify a value for the property at the end of the lease period. The loan to the SPE is for the same period as the lease, but the loan amortizes to a balloon payment. At the end of the twenty-year lease, the balloon payment will be due to the lender, which has a security interest in the form of mortgages on the premises and on the leasehold interest.

The policy that will be issued will insure the SPE for loss of value to the real estate if, at the time the balloon payment comes due, the real estate is worth less than the amount of the balloon payment. The lender will be the loss payee. The policy will not insure losses that result during the 20-year term, such as defaults in the payments by the SPE. In the event that the lender acquires the property as the result of the SPE’s default prior to the end of the 20-year period, the policy will contain requirements intended to assure against deterioration of value, even if the property remains vacant for some years. The policy does not insure against loss of value as the result of physical damage to the property.

Analysis:

Residual value insurance is defined in N.Y. Ins. Law § 1113(a)(22) (McKinney 2000) to mean:

Residual value insurance" means insurance issued in connection with a lease or contract which sets forth a specific termination value at the end of the term of the lease or contract for the property covered by such lease or contract, and which insures against loss of economic value of tangible personal property or real property or improvements thereto except loss due to physical damage to property, excluding any lease or contract that falls within the definition of financial guaranty insurance as set forth in paragraph one of subsection (a) of section six thousand nine hundred one of this chapter.

Although the above definition reads as if residual value insurance does not include a lease or contract that falls within the definition of financial guaranty insurance, since the lease or contract is not insurance, the provision must be read to mean that residual value insurance does not include insurance of such a lease or contract where the insurance constitutes financial guaranty insurance.

Financial guaranty insurance is defined in N.Y. Ins. Law § 6901 (McKinney Supp. 2000), in relevant part, to mean:

As used in this article: (a)(1) 'Financial guaranty insurance" means a surety bond, insurance policy or, when issued by an insurer or any person doing an insurance business as defined in paragraph one of subsection (b) of section one thousand one hundred one of this chapter, an indemnity contract, and any guaranty similar to the foregoing types, under which loss is payable, upon proof of occurrence of financial loss, to an insured claimant, obligee or indemnitee as a result of any of the following events:

(A) failure of any obligor on or issuer of any debt instrument or other monetary obligation (including equity securities guarantied under a surety bond, insurance policy or indemnity contract) to pay when due to be paid by the obligor or scheduled at the time insured to be received by the holder of the obligation, principal, interest, premium, dividend or purchase price of or on, or other amounts due or payable with respect to, such instrument or obligation, when such failure is the result of a financial default or insolvency or, provided that such payment source is investment grade, any other failure to make payment, regardless of whether such obligation is incurred directly or as guarantor by or on behalf of another obligor that has also defaulted;

(2) Notwithstanding paragraph one of this subsection, "financial guaranty insurance" shall not include:

(E) residual value insurance as defined in paragraph twenty-two of subsection (a) of section one thousand one hundred thirteen of this chapter.

The coverage under the proposed policy insures against loss of economic value of real property. The policy sets forth a specific termination value at the end of the lease agreement, namely, the amount of the final balloon payment. A key element of financial guaranty insurance is not present under the policy since the coverage is not conditioned upon the default of the borrower. The coverage falls squarely within the definition of residual value insurance and may be written in New York by an insurer licensed to write such insurance.

For further information you may contact Principal Attorney Paul A. Zuckerman at the New York City Office.