Insurance Issues Create Confusion and Risks for Condominium Boards and Owners

It might be possible to find an issue more prone to error and confusion than condominium insurance, but it wouldn’t be easy. Hundreds and probably thousands of treatises have been written on different aspects of this complicated topic, but like a fire that isn’t completely extinguished, the questions keep coming. New questions arise as old ones are answered; old questions are asked anew by successive generations of owners and board members confused by the same issues that confused their predecessors. I’m going to focus on three that our clients ask most frequently:

• What does the association’s master policy cover?
• Who pays the master policy deductible?
• Who’s at fault?

COVERAGE BOUNDARIES

The first question – what the master policy covers – is more complicated than it seems. Condominium associations have three coverage options:

• Bare walls — covers common areas and limited common areas, but stops outside the “bare walls” of individual units. This means the master policy does not cover items within the interior walls of the unit, such as fixtures, cabinets, interior partitions and floor covering.
• Single Entity – covers common areas and limited common areas plus the unit and its fixtures, cabinets, floors and other interior structural components. The way to think about this coverage: If you turned the building upside down and shook it, the master policy would cover everything that didn’t fall out, with this significant exception: The policy only covers the ‘like kind and quality’ of the original components the developer conveyed to the owner, which means that improvements and betterments made by the owner subsequent to conveyance by the developer are not covered. If an owner who has replaced Formica countertops with granite suffers a covered loss, the policy would pay only the replacement value of the original Formica cabinets.
• All-in or “All Walls” – adds coverage of betterments and improvements made to a unit by an owner to the single-entity coverage, to produce the most comprehensive of the three insurance options. In the above (Formica vs. granite) example, this policy would pay to replace the granite counters and cover any other alterations or improvements the owner has made since purchasing the unit.

Some condominium documents specify the type of policy required; others simply require ‘full coverage,” without specifying what that means. Of the three insurance options, “bare walls” is the least common and least desirable; all-in the most comprehensive and best choice. If the documents don’t require ‘all-in’ coverage, secondary market rules for condominium mortgages typically require unit owners to carry insurance covering interior unit components that aren’t covered by the master policy.

GOING "ALL-IN"

The board has a fiduciary responsibility to purchase insurance as required by the governing documents and sufficient to protect the association’s interests. With that obligation in mind, if the condominium documents don’t specify the coverage required, we advise boards to select all-in policies, because they eliminate concerns about gaps that might leave structural components within units uninsured. If the documents require anything other than all-in coverage, boards should consider one of three options:

• Have owners vote to amend the documents to require all-in coverage for the association.
• Have owners amend the documents to require owners to purchase gap coverage for their units.
• Have the board adopt a resolution calling for all-in coverage.

While amending the documents is always preferred, this is often not practical or cost effective. In addition to a super-majority vote of owners, an amendment may require the approval of lenders holding mortgages on the units. Identifying the lender (when mortgages change hands frequently) is difficult enough; finding the individual within a large, national institution who is able and willing to approve the insurance change can be almost impossible. Therefore, if an owners’ vote to amend the documents is not practical, we recommend the third choice (a board resolution) because it is easier and faster than the amendment process.Can boards substitute all-in coverage if the documents specify single-entity? We think the answer is yes. Bare walls or Single-entity are minimum requirements. The board couldn’t purchase inferior (‘bare walls’) coverage, but it is our position that the board does have the authority to purchase more comprehensive coverage than the documents require. To do so, boards should adopt a formal resolution, record the decision, notify the association’s insurance carrier of the board’s decision to provide all-in coverage, and make sure the policy language and the premium charged reflect that change.As a cost-saving measure, one board decided to scale back its coverage from all-in to bare walls. The association suffered a couple of losses over time that the insurer paid as if there were all-in coverage. But in reviewing another claim, the adjuster noticed the ‘bare walls’ amendment the board had adopted and denied coverage because of it.Fortunately for the association, its insurance agent wasn’t aware of the prior change and so had written an all-in policy on which the premiums were based. As a result, the claim was covered – but this could have turned out differently and badly for the association. The two clear lessons:

• Don’t skimp on coverage – you want an all-in policy; and
• Make sure any change is documented and communicated clearly to your agent and your insurance carrier.

WHO PAYS THE DEDUCTIBLE?

The question of who pays the master policy deductible is closely related to the first question – what kind of coverage does the association have – and probably rises more frequently. For a common area claim, the deductible is clearly a common expense. But what happens when the unit suffers interior damage that is covered by the master policy? The answer is equally straightforward: The owner of the unit that suffers damage is responsible for the master policy deductible. If several units suffer damage, the deductible should be apportioned among them, based on the size of their claims.To illustrate: A flood causes $60,000 in damage to one unit and $40,000 in another. The association’s deductible is $10,000. The first owner, with 60 percent of the damage, would be responsible for 60 percent of the deductible ($6,000); the second owner would be responsible for the remaining 40 percent ($4,000). If common areas are damaged as well, then the deductible would be apportioned similarly among the units and the association.While some documents specify the owners’ responsibility for paying the deductible on claims affecting their units, many are silent on the issue. This is a loophole boards should close. You don’t want to leave any room for owners to argue that the association is responsible for the deductible on any master policy claims they file. In addition to straining the association’s finances, filing multiple small claims (which owner would be encouraged to do if they don’t have to cover the deductible) would increase the association’s premium and possibly make the community uninsurable.

MAKE IT CLEAR

If the documents don’t address the deductible issue, associations should either amend their documents or adopt a board resolution making the owners’ deductible responsibilities clear. Owners, for their part, should make sure that the HO6 policy insuring the contents of their units (which aren’t covered by the master policy) includes coverage for the master policy deductible. This is especially important today, because associations are carrying large deductibles ($10,000 or more) in order to hold their premium costs down. Owners without deductible coverage are essentially self-insuring for damage to their units up to the deductible amount.How much of a problem could that be? After paying a $1.4 million claim for water damage caused by the accidental tripping of the fire sprinklers, an insurance company increased the community’s water-damage deductible to $100,000. That’s how large a problem the deductible could be for owners who don’t have insurance coverage for it.Many owners aren’t aware that deductible coverage may not be included in their HO6 policy, but is available as an add-on at a very small incremental cost. Some owners don’t purchase HO6 policies at all, which means they have no coverage for damage to their furniture and other personal possessions, nor do they have liability coverage for visitors who might suffer injuries in their units. The association’s master policy would not cover any of those claims. Boards can’t require owners to carry the individual unit insurance they need (unless the documents establish that requirement), but they can and should try to educate owners about the importance of doing so.

WHOSE FAULT IS IT?

“Stuff happens.” But when it does ― when the roof leaks or a pipe breaks, or a fire ignites — the instinct is to find someone to blame for the damage. In the insurance arena, however, fault is usually irrelevant. As long as insurance covers the damage, it generally doesn’t matter who caused it. If the neighbor’s child clogs the toilet with a large toy and the resulting flood damages the unit below, the master policy (minus the deductible) will cover the repairs. If the downstairs owners are properly insured (with deductible coverage), they shouldn’t suffer any significant out-of-pocket loss.If the association’s insurance premium increases because of the claim, should the board seek compensation from the upstairs owner, who was responsible for the damage? That makes sense until you consider that the ‘responsible’ owner is also a member of the association. By suing the owner, the association is essentially suing itself.Fault should not be part of the insurance coverage discussion in most cases but fault may be a factor if the damage is not covered by insurance and if there is negligence involved. If a leaking roof causes water damage to a unit and the roof has never leaked before, there is no breach of duty by the board and therefore no negligence on its part. However, if the board has ignored past leaks or repeatedly and inadequately patched a roof it should have replaced and the insurer denies the claim because of that poor maintenance, an owner whose unit is damaged may have a legitimate claim against the association for the damage.The advice for boards is clear: Don’t take maintenance short-cuts. And don’t take shortcuts on the association’s insurance coverage either. “Penny-wise and pound-foolish” is not an insurance policy on which you want to base a large damage claim.