Burning Down the House… Is Your Condominium Adequately Insured?

Published on: August 1, 2009

Most condominium documents require condominiums to be insured at full replacement cost. However, most insurance policies do not guarantee full replacement cost (although such policies are available on a limited basis) but typically set a dollar sum certain policy limit. The policy limit is established by the insurer based on a formula, which relies heavily upon square footage. This makes sense, as the cost to rebuild a condominium or any building is typically broken down into a square footage basis. Square footage and other information (e.g. is the building non-combustible, sprinklered, etc.) that factors into the determination of the policy limit is usually provided by the condominium board. Since this information directly correlates with the policy limit established by the insurer, it is imperative that condominium boards ensure that the information that they provide to their insurer is accurate and up to date.

Recently, a five-story condominium in Western Mass. burned to the ground. When the developer obtained the original policy for that condominium, the insurance agent understated the square footage of the building by an entire floor. The square footage error went unnoticed for several years, as neither the insurance agent nor the condominium board took any action to: (1) survey the condominium or compare the condo documents and plans to the original insurance application, which might have revealed the square footage deficiency, or (2) appraise the condominium, which might have revealed that the condominium was underinsured. Instead the insurer simply renewed the policy every year, increasing the policy limit every year by a slight (2-3%) inflationary factor. Thus while everyone, the board, the agent and the insurer all believed that the condominium was insured to replacement cost, because they all carried forward the original square footage error on the initial policy, the condominium wound up being severely underinsured when it burned down some ten years later.

This meant the condominium unit owners, fresh off of losing their homes, were forced to make up the difference to rebuild their homes and engage in protracted and expensive litigation to recoup those funds from the agent. Boards should learn from this example, and realize that making sure that their homes are adequately insured and protected from a total loss is among their most important tasks as board members. While, boards are not usually comprised of insurance professionals and will need to rely upon their professionals to a certain degree, there are steps they can take to maximize the insurable value of their condominiums.

First and perhaps most importantly, take the time to sit down with your agent and make sure you understand what kind of policy you have and what kind of policies are available. The discussion with the agent should involve much more than cost of the premium. While most condominium documents requires 100% replacement cost, many condominiums, in an effort to save on premiums (and keep condominium fees down) are insured at 80 or 85% to value. While some boards and agents do not view this as a risk, as condominiums with more than a single free standing building are not considered likely to suffer a total loss, such an approach not only violates the documents but seems fool hearty in that the single most important asset to every unit owner is being compromised in an effort to save a couple of dollars a month on condominium fees. To that end, the Board should explore whether the agent can obtain a guaranteed replacement cost policy. This kind of policy insures the actual cost to replace a destroyed condominium regardless of the policy limit. While such policies are rare in the present market and more expensive than traditional policies, they provide added piece of mind and eliminate the need to constantly reevaluate policy limits and values. Guaranteed replacement cost policies should especially be considered by condominiums consisting of a single building or a small closely situated cluster of buildings, as those condominiums are more vulnerable to a total loss.

Otherwise condominium boards need to be vigilant and cannot simply rely upon their agent. Condominium boards in the process of transitioning from developer control, should immediately review their insurance policy for accuracy and consistency with the actual square footage of the condominium building(s). Again correct square footage is essential to maximizing the policy limit and will be essential in determining the cost to rebuild the condominium in the event of a catastrophe. To this end, the Condominium documents and plans, which should detail the square footage of the building should be compared with the prior applications submitted by the developer or prior boards, which generated the policy. Condominium board’s need to be careful to review their policies annually in the event additional buildings or structures are added to the condominium. The insurance agent can be helpful in this regard as they all have software and the expertise to calculate policy limits based on square footage. Condominium board’s can also obtain insurance appraisals of their building on a periodic basis, which can then be compared with their policy limit to assist them in their determination if their complex is adequately insured.

However, it does not end there. Most policies do not include demolition costs and/or upgrades to the building required by changes to state and local ordinances. Accordingly, additional coverages such demolition and “ordinance or law” are important and need to be carefully reviewed by the board and updated annually. The Condominium board should confer with its agent and construction professionals as to potential demolition costs to ensure adequate coverage. Perhaps more difficult to ascertain is what building upgrades might be required in the event of a total loss. Many municipalities will require sprinklers and/or elevators to be added to rebuilt condominiums. It goes without saying that sprinklers and elevators are big-ticket items and can cost several hundred thousand dollars. Unfortunately, most boards gloss over these two coverages and usually obtain minimum demolition and/or ordinance of law coverage (i.e. $25,000.00 $50,000.00 each). Increasing both coverages not only makes sense in today’s unpredictable and regulated market but can be done so for minimal additional cost.

Obviously, insuring a condominium complex is not as simple as calling your agent to obtain the lowest possible premium. It is imperative that Board’s go the extra mile to ascertain that the original (and all subsequent) insurance application(s) submitted and which forms the basis for the policy is correct and to review that policy on an annual or semi-annual basis and to explore and investigate additional coverages. After all, disasters and catastrophes are stressful enough without having to deal with an insurance shortfall.