By: Nena Groskind
Insurance pitfalls. Now there’s a topic that could fill a book and probably more than one. Few issues are more important for condominium owners and association boards than insurance, and few are more complicated and more likely to trip them up.
How much coverage does the association need? What kind of coverage should it have? How high should the deductible be? Who pays it? What does the master policy cover and what does it not protect? What happens if owners don’t have individual coverage? (It’s not pretty.)
Failure to answer these questions correctly can produce the array of pitfalls we’re going to discuss here. We’re focusing on property coverage (leaving liability headaches for another discussion and another day). These aren’t the only insurance mistakes associations make, but they are the most common and potentially the most damaging for owners, governing boards, and for the community as a whole.
Pitfall Number One: Boards (and owners) don’t read the condominium documents. Multiple problems flow from the failure to perform this fundamental due diligence. “It’s like engaging in a business relationship without looking at the contract,” Greg Pierce, vice president and director of business development, NorthStar Insurance Services, Inc., observes.
“The association’s governing documents are a roadmap to understanding what insurance the association is required to have and who is responsible for covering what,” Pierce emphasizes. If boards and owners lack that basic understanding, he warns, “they may end up with significant coverage gaps.”
He uses this example. Most associations today have “all-in” policies, which would cover both common areas and structural components within owners’ units. But some documents specifically require more limited “studs-out” coverage, and, Pierce explains, insurers will cover only the property for which the association is legally responsible. You may have a thousand times the coverage you need for all-in coverage, but the insurer will only pay for studs-out.”
Pitfall Number Two: Owners don’t obtain HO6 policies. This is a perennial problem that continues to defy the efforts of association managers, board members, insurance professionals and others to explain why condominium owners need HO6 policies, to obtain protection the Master Policy won’t give them.
Most associations encourage (or strongly encourage) owners to purchase an HO6 policy; some adopt resolutions or amend their bylaws to make the policy mandatory. But despite the encouragement, resolutions and pleas, some owners still assume the Master Policy fully protects them and fail to obtain the unit owner’s coverage they need. They could find themselves seriously under-insured if their unit suffers serious damage.
“Owners and boards need to understand where the Master Policy coverage ends and where the policy provided by a unit owner’s (HO6) policy begins,” Pierce emphasizes. And owners need to make sure the policies overlap. “There’s a lot of room for error here,” he cautions.
Jared McNabb, CMCA, PCAM, recently named general manager at The Brook House in Brookline, has traditionally organized annual insurance seminars for owners at the properties he’s managed. When he asks who has an HO6 policy, McNabb says, “There are always some owners who don’t have the insurance, aren’t sure if they have it, or don’t know what it covers.”
Deductibles and Displacement
In addition to covering an owner’s personal property and unit damage the association’s master policy wouldn’t cover, the HO6 should pay the owner’s share of the Master Policy deductible. On a Master Policy claim for damage only to an owner’s unit, the owner would bear sole responsibility for the deductible, and that’s no minor expense. As more associations accept higher deductibles to reduce their premium costs, deductibles of $10,000 or more are common.
“Owners who don’t have deductible coverage don’t realize that they are essentially self-insuring for $10,000 or $25,000 or more,” McNabb points out. “That’s a check most owners would not be happy to write.”
The HO6 policy should also provide displacement coverage paying living expenses if owners are forced to relocate temporarily while a damaged unit is being repaired. This is another area where owners are not as well-informed as they should be. “Any time I discuss displacement coverage with an audience of owners,” McNabb says, “I see a lot of confused looks and a lot of people [furiously] taking notes.”
He recalls talking to a woman whose unit had suffered major water damage from a leak that originated several floors above her. Angry and extremely agitated, the woman wanted to know, “Where are you putting me up tonight?” She was not at all happy when McNabb explained that the association’s Master Policy wouldn’t pay her expenses; she was going to have to cover those costs.
“Loss of use coverage for owners is a standard feature of the HO6 policy,” Pierce confirms. “But the association’s Master Policy will never provide it.”
The conversation McNabb had with the angry owner is a conversation no manager wants to have with owners after a disaster, Pierce notes. “It’s another example of the problems that arise when owners don’t understand their insurance responsibilities. If owners and boards are on the same page and understand who is responsible for covering what,” he says, “these conversations don’t have to occur.”
One detail managers and insurance professionals emphasize: While displacement coverage is necessary and inexpensive, it isn’t included automatically in the HO6 policy. It’s an endorsement that owners have to request.
“Don’t assume you have it,” McNabb advises owners, “and don’t assume your agent has added it for you. Ask for it and make sure it’s there. [Having the coverage] can make a difficult situation a lot easier,” he says. Not having the coverage can make a bad situation a lot worse.
More HO6 Protection
The HO6 provides other essential coverage for owners, including:
• Coverage for liability claims – if someone is injured in the owner’s unit; and
• “Loss Assessment Coverage” – paying the owner’s share of a special assessment levied to cover the shortfall, if the Master Policy doesn’t fully cover an association claim.
Stephen Marcus, Esq., CCAL, a partner in Marcus, Errico, Emmer & Brooks, PC, notes an interesting quirk in loss assessment coverage: Owners may be able to obtain this insurance after-the-fact. It’s well known that you can’t increase the amount of coverage for your house after it’s been destroyed in a fire. However, Marcus explains, loss assessment coverage in a condominium would be triggered by the assessment, which won’t come until the insurer has calculated the loss and the association has identified the coverage gap. Using that interpretation, an owner might be able to purchase loss assessment coverage after the disaster has occurred, but before the board has approved the special assessment.
“This sounds wrong, but it is probably correct,” Marcus says, “and it would certainly be worth exploring with your insurance agent.” While insurance companies might well resist, he adds, “it’s a battle owners might want to fight.”
Pitfall Number Three: Associations set their property coverage limits too low. This problem results because boards assume that the coverage limit should match the purchase price, and/or that the stated coverage limit in the policy will guarantee enough coverage to repair or replace the building. Neither assumption is correct.
“The coverage limit is the maximum the insurer will pay if there’s a loss,” Ellen Shapiro, a partner in Goodman, Shapiro & Lombardi, LLC, explains, so you want that limit to be high enough to replace the property if it is destroyed today. “That is certainly not going to be the same as the original purchase price and it may not be the current appraised value,” she notes. It’s not the original purchase price or even the building’s current appraised value that you’re targeting, Shapiro emphasizes. “Rebuilding, not resale, is the name of the game.”
The ideal coverage for associations is ‘guaranteed replacement cost, where the insurer promises to pay whatever it costs to rebuild a damaged structure. But that coverage isn’t widely available. Most polices instead cover the property’s stated value. But the stated value only represents the insurer’s estimate, Marcus cautions. “It’s not a guarantee” that the coverage based on that value will be sufficient, “and agents will be the first to tell you, they aren’t valuation experts.” If their estimate of value is too low, the coverage limit will be too low, as well. For that reason, Marcus advises boards to obtain an “insurance replacement appraisal” from an independent expert who provides that service, and to update the appraisal at least every three years to make sure their coverage limits accurately reflect the likely replacement costs.
Some industry executives recommend an “inflation guard,” which will automatically increase the property’s stated value by a specified amount every year. But this is also an estimate, Pierce points out. If inflation is higher than the adjustment factor, the association will be under-insured. But automatic adjustments can create the opposite problem, Pierce notes. He uses this example: If the stated value of a building is $5 million and the inflation guard increases that by 4 percent every year – with compounding, after five years, you’d be insuring for $6 million. “If it only costs $5 million to replace the building, you’re carrying and paying for more insurance than you need.”
An inflation guard provides automatic protection for boards that don’t renew their coverage limits every year. But he thinks an annual review “to make sure the limits still make sense,” is a better strategy.
Pitfall Number Four: Boards omit some coverages they need. Ordinance or law coverage is a particular concern. It’s an endorsement (which means boards usually have to request it) covering the cost of meeting code requirements that didn’t exist when a building was constructed. If an older building is destroyed or seriously damaged, Marcus explains, “unless the association has this coverage, the insurer won’t pay a penny for the cost of installing a sprinkler system that didn’t exist and wasn’t damaged.” Associations also need a separate endorsement that many fail to purchase to cover demolition costs, which, Marcus notes, add thousands of dollars to reconstruction costs.
Some insurers will offer limited ordinance or law coverage – typically capped at $250,000 – as part of their standard policy, “but that’s not close to what would be required to bring some older buildings up to code,” Marcus notes. “In a weird way, it’s almost better if the policy doesn’t include the coverage,” he suggests, “because that will force association boards to consider the issue,” and do what he thinks they should do: Hire an architectural firm that knows the building code to estimate what it would cost the association to meet its requirements today.
The fee for this analysis will be high, Marcus agrees, “certainly higher than the cost of a property appraisal.” But the information is essential, he says. “There is no surer way for a condominium board, manager, insurance agent, or even an insurance carrier to get sued,” he warns, “than to have a bunch of angry unit owners who don’t like the idea that they will have to share a $3 million assessment to replace a building,” because the association didn’t have the coverage it needed.
Also on the list of essential coverage that insurance experts recommend but associations don’t always obtain: Flood; earthquake (seismic risks here are little recognized but significant, Marcus notes, and many of the stately old downtown buildings “are sitting on fill.”); boiler and machinery coverage (to repair or replace that equipment if it’s damaged in a fire, flood, or other disaster); unowned automobile coverage (essential even if the association doesn’t own a car, to cover a board member who has an accident while driving his/her car on association business); and workers compensation – also needed even if the association has no employees, because an un-insured or under-insured worker injured while working on association property will almost certainly sue the association.
Pitfall Number Five: Boards and managers don’t always communicate insurance information effectively to owners. This isn’t just a matter of explaining HO6 policies and why owners need them. It is equally important, Pierce says, to explain insurance protocols. Owners don’t always understand, for example, that they shouldn’t contact the association’s insurance agent directly; they should call the board or the manager to report claims or ask questions about them.
“I don’t mind fielding an occasional phone call from an owner,” Pierce says. But answering 30 queries from 30 different owners calling about the same claim would be neither welcome nor particularly efficient.
Allowing owners to file claims directly with the agent or the carrier could also be costly for the association, Pierce points out. A board might have concluded that it is better for the association to pay small master policy claims to avoid a premium increase. Owners, unaware of that risk management strategy, might file a claim the association would have preferred not to report. “It is much better for the association if the board and the manager handle the claims process,” Pierce says.
Pitfall Number Six: Boards don’t give insurance sufficient thought. Insurance is a lot more complex than most people realize, Pierce says, and boards responsible for purchasing coverage should recognize the complexity and “give the insurance process the respect its due.” That means, among other things, not focusing exclusively, or even primarily on price. If your only concern is the premium, he cautions, the association may not get the coverage it needs. “It’s not just a matter of getting what you pay for,” he adds. “In a competitive marketplace, you can get a good price for appropriate coverage” – but only if you understand what constitutes appropriate coverage for your community.
Pitfall Number Seven: Boards don’t get the expert insurance advice they need. And that advice should come for an agent who specializes in condominium insurance, Marcus emphasizes. “Under my health insurance policy, it costs me no more to use the best doctors than the worst,” and he suggests, the same theory applies to insurance agents. “It won’t cost any more to use one of the top-tier agents, who are known for working with condominiums,” he explains. Working with a less knowledgeable, less experienced agent, on the other hand, could end up costing the association a great deal.