Paycheck Protection Program Loan Contingency Insurance

August 26, 2020

The Paycheck Protection Program (PPP) was put in place to provide forgivable loans to organizations impacted by COVID-19. During the PPP loan application process, borrowers were required to provide documentation and to make several certifications in connection with their application for the PPP Loan. These certifications at the time of application, included certifying the following:

1. “Necessity” Certification: “Current economic uncertainty makes this loan request necessary to support ongoing operations of the Applicant” (which would include subsequent guidance issued by the Small Business Administration (SBA) that the loan recipient should consider access to alternative sources of liquidity prior to making this certification).

2. Employee Count Certification: Employee count of 500 or fewer employees (which takes into account any affiliated entities as defined by the SBA affiliation rules).

Many borrowers have concerns that as the details of the PPP have been clarified, they could become liable for the repayment of loans that they believed would be forgiven. The SBA has provided answers to numerous Frequently Asked Questions regarding PPP loans. Question 46 gives specific guidance on “if the SBA determines in the course of its review that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request, SBA will seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower is not eligible for loan forgiveness. If the borrower repays the loan after receiving notification from SBA, SBA will not pursue administrative enforcement or referrals to other agencies based on its determination with respect to the certification concerning necessity of the loan request.”

If a business cannot repay or elects not to repay a PPP loan after receiving an adverse determination by the SBA, the business could face potential liability not only for repayment of the loan but also for fines, penalties and defense costs.

Paycheck Protection Program Loan Contingency Insurance has recently become available to provide protection for some of the uncertainty of a business being denied loan forgiveness if it is deemed by the SBA to have been ineligible to receive a PPP loan at the time it was granted based on the “Necessity” and Employee Count Certifications. The insurance is currently not intended to cover issues related to how the loan funds were used, False Claims Act claims or the investigation process (which the government has indicated is nearly a guarantee for loans over $2M).   However, this is a new insurance policy and the coverage terms are evolving.

Coverage applies once the SBA has made an adverse determination on eligibility for forgiveness of the loan because the business lacked adequate basis for the “necessity” and employee count certifications. Covered loss would include the sum of the forgiveness of the loan permitted under the PPP if the business had an adequate basis for these certifications and would also include accrued interest and defense costs relating to appealing the adverse judgement of the certifications. Since the loan was provided to the business, the Named Insured on the policy will be the business entity and any of its subsidiaries; however, coverage is not extended to the individual directors, officers or employees. It is also important to note that the policy will be subject to a fraud exclusion related to an underwriting application warranty signed by the CEO or President that, at the time of the insurance application, there is no reason to believe the information provided in the PPP loan application or the insurance underwriting process is materially inaccurate or misleading.  Given the sheer number of PPP loans, it could take the SBA years to review even just the largest loans. This creates the uncertainty of a potential liability on the balance sheet of a business which could negatively impact future activities such as limiting the amount of bank financing or the valuation of the company in a Merger & Acquisition. Paycheck Protection Program Loan Contingency Insurance can also provide reassurance to third parties regarding this uncertainty.

Coverage Details:

i. Coverage applies based on certifications in a PPP loan application regarding the “necessity” of the loan and the employee count (which takes into consideration the affiliation rules) and must be purchased prior to receiving an adverse determination from the SBA

ii.  Target loan size: $1 million to $10 million

iii.  Retention: $200,000 minimum (subject to the quality of the risk)

iv.  Premium: 3% to 4% of the limit of liability (subject to the quality of the risk)

v.  Due Diligence Fee: $25,000 to $50,000 – Due if initial terms are accepted by Insured

vi.  Policy Term: 5 years

vii.  Paycheck Protection Program Loan Contingency Insurance is a new insurance coverage and coverage terms are expected to continue to evolve.

The insurance underwriting of this policy is a two-step process:

Step 1 – Initial Underwriter Review: When the required information is submitted, the underwriters will make an initial review of the material and provide an indication of pricing and any specific coverage issues. The indication will also include a list of additional documentation that is needed.

Step 2 – Due Diligence Review and Payment of Review Fee: This 2nd step of the underwriting process requires the review of the information by outside tax accountants hired by the underwriters which is why there is a substantial due diligence fee that must be paid before coverage can be bound.  This due diligence review process is also intended to eliminate adverse selection of a company purchasing this insurance because they know there may have been misstatements in the certifications provided for their PPP loan. Once the complete submission is received and the due diligence fee of $25,000 to $50,000 is paid, the outside tax accountant review will begin and then subject to a favorable review, the underwriters will endeavor to provide a formal quote.

Initial Information Needed for Insurance Application:

i. Copy of Original Application for PPP loan and attachments

ii. Name of the company, class of business, location, number of employees, affiliates, limits requested, explanation of how payroll calculations were performed

iii. General summary of how COVID-19 affects their business

iv. Financial performance year-to-date

v. Analysis of the application of the SBA Affiliation rules. The Affiliation rules are defined by SBA regulations and address how stand-alone companies that have common control could be regarded as affiliated companies and therefore not eligible for PPP loans if the affiliated group has more than 500 employees.

vi. Description of how “need” was assessed and working papers to support analysis. This can include working capital analysis, notes regarding borrowing options and other documents that demonstrate that additional funding was not available at a reasonable cost.

If you are interested in Paycheck Protection Program Loan Contingency Insurance, please let us know.

G. Martin Irons, CPCU, CIC, ARM
Vice President - Technical Development Department
The Graham Building
Philadelphia, PA , 19102
215-701-5266
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