Creditor Mandated Purchases of Corporate Insurance
43 Pages Posted: 26 May 2010 Last revised: 1 Feb 2018
Date Written: May 1, 2010
We present novel empirical evidence on the contractually mandated purchase of insurance by corporate creditors. In a large sample of private credit agreements of publicly-traded firms, we find that nearly all agreements contain at least a boilerplate provision requiring the borrower to purchase insurance. In about 80 percent of the agreements, the insurance covenant is more explicit. We focus on four additional features of the insurance covenant: explicit permission for the borrower to self-insure, requirements of coverage for specific risks, naming the lender as a loss payee, and mandating that any insurance proceeds be used to repay the loan. We find that credit agreements contain more stringent insurance requirements for borrowers that are smaller and pose higher credit risk, measured in a variety of ways. We also find that insurance requirements are highly correlated with many other terms of the loan and are very strongly positively correlated with the loan being secured by collateral and the loan size being limited by a borrowing base. This latter evidence suggests that insurance creates value by protecting lenders from unexpected changes in seniority that might happen following the destruction of collateral or the occurrence of a large liability suit. Mandatory insurance requirements appear to be an important ingredient of credit agreements designed to encourage monitoring by senior, secured lenders.
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