EXPLAINER: How Residual Value Insurance really works – Q4/22

Residual Value Insurance (RVI), also known as equipment value insurance or asset value insurance, provides protection to leasing companies and lending institutions for residual asset value at the termination date of a lease or loan following a remarketing process and providing that the asset is in return condition. RVI covers a clearly defined risk of a loss of an underlying asset’s value at the end of a lease contract due to unforeseen market fluctuation.

What are the benefits of RVI policies?

RVI is designed to give lessors and lenders a “floor” to transactions in the event of a collapse in asset market value. By removing residual value risk, this enables:

Lessors to borrow more against assets with less equity capital required
Greater flexibility in transaction structuring and lease accounting, potentially also offering tax advantages for lease payments
Lenders to consider higher balloon payments with lower monthly payments for lessors
Lenders and lessors to hold less solvency and economic capital associated with market risk of residual asset values
A competitive cost advantage to lenders vis-à-vis competitors with lower cost of capital and higher net interest margin, which may be used to win new business

What does a RVI policy cover and what does it not cover?

An RVI policy covers a clearly defined risk of a loss of an underlying asset’s value at the end of a lease contract due to unforeseen market fluctuation (following a predefined remarketing period) provided that the asset is in return condition normally as defined in the lease.

RVI policies do NOT cover:

Accidental Damage – RVI does not cover an asset’s loss of value due to accident or damage other than normal wear and tear. A third party expert opinion is always sought about the return condition of the asset.

Disaster or Catastrophe – RVI does not cover any damage to the asset, in the event of a total loss before the end of the lease.

Credit Event – RVI does not provide bankruptcy coverage. If assets are at the end of their lease term, and following the remarketing period, Insurers have the right to take ownership of the asset or pay the Insured the difference between policy limit and the best offer available. Insurers will if they take ownership, sell or re-lease the asset to cover the loss.

Excessive Use – RVI policies specify the “return conditions” of the asset (normally as per the lease/loan). Excessive use may violate the “return conditions” or the policy limit may be amended to take the excessive usage into account up to a pre-defined amount.

Lease Extension – An agreement between the lessor and the lessee to extend the lease would end the RVI policy agreement. However, a policy period could sometimes be extended with a new, renegotiated premium.

Which types of commercial assets are suitable for RVI?

RVI is written on “real” assets such as aircraft, ships, trains, containers, yellow goods, and commercial real estate.

Assets that are best suited to RVI typically have a longer economic life, are in newer condition, are less subject to technological obsolescence, are well-maintained during the policy period, hold their value over time and have a secondary market available for sale and leasing.

Assets that are less well suited to RVI include consumer goods, virtual assets, assets whose value swing significantly and/or are less predictable, assets with less demand at the end of a lease period, assets that are not well maintained or are subject to a lot of accidents and repairs.

What are the key terms and conditions of a RVI policy?

RVI policies typically correspond with the end of a leasing or financing transaction.

Certain policies are for single assets (e.g. aircraft, ships, etc.) while others are for fleets (equipment, vehicles, etc.).

Policies will specify “return conditions” for the assets insured. Return conditions specify the designated location, date and conditions that the asset needs to be in for the policyholder to make a claim and will usually dovetail with the requirements of the Lease/Loan.

Insurers may also require the policy holder to co-insure a portion of the residual value to better align interests in ensuring that assets are returned in a condition suitable for resale or re-leasing.

The policyholder is usually required to notify Insurers 12-18 months prior to the policy end date of their intention to make a claim. The period between the notification date and the policy end date, referred to as the remarketing period, is to try to sell or re-lease the asset. A claim can only be paid if the remarketing has taken place satisfactorily.

Remarketing may be undertaken by the Lessee or Insurers depending on the type of assets and policy conditions agreed however Insurers will always have the right to step into the remarketing process if they feel they can help.

What level of residual value will Insurers cover?

The level of residual value that Insurers are prepared to underwrite depends on several factors:

Demand for assuming the residual value risk of this type of asset, duration and size of risk
Forecasts of asset valuations at policy end dates – fair market values, soft market values, scrap values etc.
Volatility in asset valuations (the more predictable the better!)
The liquidity of the secondary market for the assets (the more established the secondary market, the better!)
Time, cost and effort to assess conditions of returning assets and to remarket them
Available insurance market capacity for residual value risk

Typically, residual value covered by Insurers will be between 30% – 80% of the estimated residual value of the asset as at the policy end date depending on the asset and Insured’s requirements.

The higher the coverage level from Insurers, the higher the risk assumed and correspondingly the higher the RVI premiums. Insurance premiums for RVI policies are typically paid 100% on the day the policy begins.

What is the process for a Residual Value Insurance policy?

RVI policies are agreed and negotiated on a case-by-case basis and typically take 2-3 months to obtain agreement for a first transaction. Once a transaction has attached, any following transactions will normally be on a repeat documentation basis cutting that lead in time down to around 2 weeks.

Complete proposal forms and provide supporting information – this would typically include company history and experience, business plans and asset uses, financing structure, leasing and financing agreements, forecast valuation reports for residual values, financial security requirements, etc.

NB: An upfront application fee or underwriting fee may be required to cover upfront costs incurred.

Review information and prepare presentation for Insurers – This often includes structuring the risk, proposing terms, outlining timelines, undertaking additional valuation work, etc.

Present risk to Insurers – This stage involves identifying and contacting prospective markets, discussing risk appetite and insurer-specific requirements. Often, deals will involve multiple insurers and re-insurers.

Obtain Non-Binding Termsheets from Insurers – Insurers will assess the risk, undertake various internal reviews (underwriting, actuarial, reinsurance, claims, fronting, etc.), and if interested will provide a Non-Binding Termsheet specifying coverages, return conditions, claim procedures, pricing, subjectivities and internal approvals.

Accept Non-Binding Termsheets and Negotiate Final Terms – Insurers will need to review lease documentation, final valuation information and ensure that nothing has changed. Typically, the client and Insurer(s) would instruct lawyers to finalise the RVI policy terms and supporting information.

Final Approval – The client and Insurer sign-off final documentation and upon receipt of premiums, the RVI policy is active.

” Assets that are best suited to RVI typically have a longer economic life, are in newer condition, are less subject to technological obsolescence, are well-maintained during the policy period, hold their value over time and have a secondary market available for sale and leasing. Assets that are less well suited to RVI include consumer goods, virtual assets, assets whose value swing significantly and/or are less predictable, assets with less demand at the end of a lease period, assets that are not well maintained or are subject to a lot of accidents and repairs. “

About the Author

Nicholas (Nick) is a highly regarded member of the London Insurance Community having worked in and around Lloyds of London for 30+ years as both Broker and Underwriter in various classes of insurance. During that time has successfully underwritten many transactions in various asset fields including Aviation, Marine, Real Estate, Equipment and other Transportation. Nick is one of a handful of recognised RVI Underwriters in the world.

Nick began his Underwriting career in 2005 with QBE and since then he has also worked for Barents Re and QIC Global.

Prior to starting Underwriting Nick worked in the Lloyds broking market for Companies such as Sedgwick (Marsh), Leslie and Godwin and Heath Lambert.