Legal Definitions - loss-payable clause

A loss-payable clause is a specific provision within an insurance policy that directs the insurance company to pay any claim proceeds directly to a party other than the policyholder. This is most commonly used when a third party has a financial interest or security interest in the insured property. The clause ensures that if the insured property is damaged or destroyed, the entity with a financial stake (such as a lender) is compensated first, up to the amount of their interest, before any remaining funds go to the policyholder. It protects the financial interest of a third party without making them an actual policyholder or giving them all the rights of the policyholder.

• Example 1: Car Loan

  Imagine Sarah buys a new car and finances it through a bank. The bank holds a lien on the car, meaning they have a security interest in it until the loan is fully repaid. Sarah's car insurance policy will include a loss-payable clause that names the bank. If Sarah's car is totaled in an accident, the insurance company will pay the bank directly for the outstanding loan amount, ensuring the bank recovers its investment before any remaining funds are paid to Sarah.

• Example 2: Business Equipment Financing

  A small manufacturing company, "Innovate Tech," takes out a loan from a financial institution to purchase a specialized, expensive piece of machinery. The lender requires Innovate Tech to insure the machinery and include a loss-payable clause in their property insurance policy. This clause names the financial institution. If the machinery is destroyed by a covered event, like a factory fire, the insurance payout for that equipment will go directly to the lender to cover the outstanding loan balance, thereby protecting the lender's financial interest in the collateral.

• Example 3: Rental Property Mortgage

  John owns a duplex that he rents out, and he has a mortgage on the property with "City Bank." As part of the mortgage agreement, City Bank requires John to maintain property insurance and include a loss-payable clause in the policy. This clause specifies City Bank as the recipient of insurance proceeds in case of a covered loss. If the duplex suffers significant damage from a storm, the insurance company will pay City Bank directly for the amount owed on the mortgage, ensuring the bank's financial interest in the property is secured before any funds are released to John.