Unless you can afford to purchase your home or car outright, you’ll need to obtain financing to pay for it (this includes leased vehicles as well).
The Bank Is the Loss Payee or Lienholder
The bank or financial institution that lent you the money is referred to as a “lienholder” or “loss payee” on an insurance policy.
When you borrow money for a home or a car, the person or institution that provided the financing holds the title until the loan is paid back in its entirety.
In effect, you can live in the house or drive the car, but you do not own it outright until the loan is actually paid off.
The lienholder/loss payee is the person or organization whose name is listed first on the check from an insurance company in the event of a physical damage claim.
Again, this is because they are the actual owners of the property until the loan is paid in full.
Financing Company Will Require Physical Damage Coverage
In order to qualify for a mortgage or a loan, the bank will require that you at least have physical damage coverage. This is to protect their “interest” in their property.
However, physical damage coverage for your vehicle is not a requirement by law in any state, mainly because your risk appetite is your prerogative (assuming you own outright).
Let’s Look at an Example
So let’s look at an example to illustrate why a lienholder or loss payee is listed as a named insured in an insurance policy.
Say you get a $20,000 loan to finance a pre-owned vehicle. One month after the purchase, you get into an accident that completely destroys the car (or it is stolen and not recovered).
If the vehicle wasn’t insured for at least the amount of the associated loan, you would be stuck with a outstanding balance and no car.
Obviously, you would have no motivation to pay off the loan and probably wouldn’t end up doing so.
That’s where physical damage coverage comes in; you have two options if your car is totaled, lost, or stolen.
You can elect to have your car replaced with a similar, new car and continue to pay the original loan to the bank.
Or you can ask that the insurance company pay off the loan and relieve you of your obligation to pay the loan back and give up your car in the process.
The latter is often a motivation for insurance fraud when people no longer want to pay for a car loan they don’t want/can’t afford.