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Borrowers' insurance protects the value of collateral and also the borrower's ability to pay. If collateral is destroyed and cannot be repossessed, a loan could become uncollectible. Insurance protects the bank's collateral by either paying for repairs or paying off the loan. Examples include fire insurance on a building, theft insurance on an inventory of jewelry, or collision insurance on a truck.

Anything that reduces revenues or increases expenses is a threat to a borrower's ability to pay. Examples include loss of revenue caused by fire, loss of sales caused by the death of a key sales person, or even the catastrophic cost of a personal injury lawsuit. In many cases insurance can reduce these threats, and improve the bank's position. Examples of "ability to pay" insurance include key person life or disability, business interruption, extra expense, general liability, or workers' compensation.

Less attention is given to "ability to pay" insurance than to collateral coverages. Lenders sometimes require life, business interruption, or liabilty insurance, but they are requested less requentlyt than coverage on collateral. Nevertheless, "ability to pay" insurance is often as important as collateral coverage.

Regulators and buyers of loans are concerned about borrowers' insurance too. Both require documentation of coverage at closing and systematic follow-up during the life of the loan. Lenders also benefit from borrowers' insurance in another, mroe indirect, way. Insurance companies examine an applicant's property, business experience, and loss history. If insurance is required for the loan, and the applicant does not qualify, the loan can be refused. In this way, insurance underwriters provide an additional test of loan quality.

Finally, insurance is important to lenders because it adds to the stability of the borrower's business. By reducing the threat of unexpected loss, insurance increases the chance that the borrower will be able to repay current loans and make additional loans in the future.