The updated SOP 50 10 8 (“SOP”) has replaced the long-standing “do what you do” flexibility with stricter underwriting expectations, making insurance a more critical component of the lender’s credit decision.

Under the standard of prudent lending, banks are expected to evaluate whether the insurance policy aligns with industry standards based on the property type, business operations, and geographic risks. Indeed, the SOP reinforces this expectation by requiring all pledged collateral to be insured to full replacement cost whenever possible. If full replacement cost coverage is not available, the policy must be written for the maximum insurable value, ensuring the highest level of protection achievable under the circumstances.

A critical concept for lenders to understand in this context is the difference between replacement cost coverage and actual cash value (“ACV”) coverage. While replacement cost coverage provides full reimbursement for rebuilding, ACV coverage pays the replacement cost minus depreciation. This can significantly reduce the amount of insurance proceeds available, particularly for older properties or equipment that have depreciated over time. The use of ACV coverage instead of replacement cost coverage creates a risk by which, in the event of a loss, the borrower may receive insufficient funds to fully restore the collateral, creating a gap that must be covered out of pocket. This can strain the borrower’s financial position and increase the likelihood of default.

Another important consideration is the distinction between admitted and non-admitted insurance carriers. Admitted carriers are licensed and regulated by the state insurance department, must comply with state requirements governing rates and policy forms, and participate in state guaranty funds that provide protection in the event of insolvency. Non-admitted carriers, also known as “surplus lines carriers,” are not licensed in the state but are permitted to insure risks that the admitted market cannot accommodate. These carriers are not subject to the same regulatory oversight and do not participate in guaranty funds, but they are often necessary for higher-risk exposures.

Although the SOP does not mandate the sole use of admitted carriers, the insurance policy must still meet the SBA insurance requirements while also satisfying prudent lending standards. This means that non-admitted carriers can be used in appropriate circumstances, particularly when coverage is not available in the admitted market or when the risk involves unique or challenging characteristics. In such cases, lenders should carefully document why admitted coverage was not feasible and why the selected non-admitted carrier and policy are still considered commercially reasonable and reliable.

In practice, this framework reinforces the need for lenders to take a more active and analytical role in evaluating insurance. For institutions operating under various SBA lender licenses,  the focus should be on the adequacy and quality of coverage, with a strong preference for replacement cost valuation whenever it is available. When exceptions arise, whether related to valuation methods or carrier type, those decisions should be supported by clear rationale and documentation.

For further assistance please contact the SBA attorneys at Starfield & Smith, P.C. at 215-542-7070 or email us at info@starfieldsmith.com.