Getting Covered: An Insurance Primer

Published on: November 22, 2002

The rising cost of property and liability insurance premiums and the shrinking scope of the coverage available have been sources of continuing and increasing concern for apartment building owners and community associations. The scramble to find the most cost-effective coverage has highlighted a problem that has always existed, but was less obvious in less tumultuous insurance markets — those responsible for purchasing insurance often do not know:

What kind and how much insurance coverage they need;What their existing policies cover; and, equally importantWhat their policies do not include.

As a result, many properties have serious coverage gaps that often do not become obvious until after a disaster, when the insurer pays less than the amount of the loss, or declines to pay anything at all.

How Much Is Enough?

When community association boards ask, as they often do, “How much coverage is enough?” insurance agents I know invariably reply, “How much can you afford?”

It may be possible to be too rich or too thin, but it is very difficult to have too much insurance today, and very risky to have too little. I haven’t conducted a scientific survey, but I am reasonably certain that most community associations and apartment buildings are woefully under-insured. The Fannie Mae requirement for condominiums (and thus the industry standard) calls for $1 million in general liability coverage. But the amount of coverage needed to make Fannie Mae’s underwriters comfortable is not necessarily the coverage needed to protect a community association (or an apartment building owner) from a potentially ruinous liability claim. There was a time when $1 million sounded like a lot of coverage – but that was long before $5 million and $10 million judgments had become almost routine.

I asked the apartment managers attending a recent Institute of Real Estate Management seminar to indicate, with a show of hands, how much insurance coverage they had. Out of 70 managers in the room, only 2 still had their hands raised at $10 million. How would your real estate company or your community association handle a $32 million judgment awarded to a tenant or a unit owner claiming damages related to mold? What about an accident in which your building superintendent accidentally ran over and killed a child in the parking lot? A $1 million policy would not begin to cover the likely jury award.

Given the financial risks, nothing is more important than the insurance protection you have in place. But I don’t think there are more than five people – including insurance agents – who have ever read their insurance policy or who understand exactly what it covers. What you don’t know about your policy can definitely hurt you. One recent example: A condominium in Gloucester was destroyed completely by fire a few months ago. When the association filed its claim, they discovered that because of a measurement error, the policy understated the size of the development by 10,000 sq. ft. As a result, the coverage was less than required to rebuild the community.

Guaranteed Replacement

In this case, the association will probably be able to sue the insurance agent, or the insurance carrier responsible for the error. But in the meantime, the owners are facing a $50,000 to $70,000 per unit special assessment to cover the insurance shortfall. They could have avoided this problem had they insisted on guaranteed replacement cost coverage, which would have paid whatever was needed to rebuild the development. This coverage is available and affordable, but it isn’t offered by all carriers. So associations have to know enough to request the coverage, and they must make sure the agent they are using represents a company that provides it. If you don’t have guaranteed replacement coverage, you should have your property appraised annually to make sure your coverage is adequate (building standards change and costs increase over time). Also be sure you add coverage for any additions you have built or improvements you have made since the existing policy was issued.

Having enough coverage is critical, but allocating it properly is equally important. A stick-built suburban town house condominium paid $11,000 annually for a policy that provided 100 percent replacement coverage for earthquake damage. That was probably overkill, given the relatively low risk that a quake would completely destroy a complex of this type. On the other hand, this community had a $55,000 per building deductible for wind damage – an extremely high risk for these buildings, which were located on a hill. Having the right amount of coverage overall won’t help if your policy leaves you exposed in the areas where you most need protection.

These are the kinds of issues community associations and apartment owners should consider, but often don’t. Most treat insurance like a commodity and shop for it based almost entirely on price, without considering the nuances that may make one policy, even if somewhat more expensive, a more cost-effective choice than another.

Shopping for Insurance

The best way to shop for an insurance policy is to issue a request for proposals and then have an insurance advisor evaluate the bids you receive, explaining the similarities and the differences, and comparing the costs and coverage different companies are offering. Few apartment owners and fewer community associations actually use this approach, however. In that IREM conference I mentioned earlier, only 2 of the 70 managers said they relied on insurance advisors; most weren’t even aware that they existed.

If you aren’t working with an advisor, you should deal with an insurance agent who specializes in the coverage you need. This is particularly important for community associations, because condominium insurance is complicated and unique; your brother-in-law or a friend of a friend who happens to be an insurance agent is not likely to be the best choice. You want an agent who can analyze the association’s coverage and make sure it dovetails properly with the unit owners’ policies. Otherwise, the association and individual owners could end up paying too much for coverage, or discover after-the-fact that no one had the coverage they needed.

Problem Areas

Having the coverage you need in the areas in which you need it is the biggest challenge. The areas most often overlooked or structured improperly include:

  • Deductibles and shifting loss.  Although some associations have moved to higher deductibles, all associations should consider increasing their traditional $1,000 deductible to $2,500, $5,000 or $10,000 to reduce premiums. Together with higher deductibles, associations should review their documents and consider adopting a resolution or amendment requiring unit owners suffering damage covered by the condominium master policy to pay the association’s deductible. Unit owners are typically able to cover most of this risk through their own home owner policy. A few forward thinking associations are now requiring owners to carry a home owners’ policy and to produce evidence of this coverage.
  • Agreed amount endorsement. This coverage eliminates the penalty that would apply if it turns out that your community or your building is under-insured. If you have only $10 million in coverage on a building that should be insured for $20 million, the insurer would be required to pay only half of any claim — $50,000 on a $100,000 loss. An agreed amount endorsement would ensure full coverage despite that gap. This coverage is affordable and readily available, but you have to request it.
  • Non-hired auto coverage. Assume that a board member conducting trust business accidentally kills someone in an automobile accident. If his personal coverage isn’t adequate to cover the claim, the victim’s family can sue the condominium trust for the balance. For an additional $50 to $75 a year, a community association can obtain $1 million in coverage for this risk. Few community associations and apartment owners have this protection; all of them need it.
  • Workers’ compensation. This coverage is necessary even for associations that do not have any employees. Consider this not uncommon situation. A worker responds to an emergency in the middle of the night. Focused on the pipe that is spewing water by the gallons into the common area, no one bothers to obtain a certificate of insurance verifying that the contractor who employs the worker has insurance. The worker is injured and the contractor, in fact, provides no coverage. The Industrial Accident Board in this case is likely to find that the association is the employer and is obligated to pay the worker’s medical expenses.
  • Directors’ and Officers’ liability coverage (D&O). These policies typically will cover claims for fair housing discrimination, unfair employment practices, and the like. You want a duty to defend policy, which will pay your defense costs, versus simply an indemnity policy, which will pay if you lose a suit, but won’t cover your litigation costs in the meantime. Make sure your policy specifies that the coverage limit does not include the defense costs; otherwise, legal expenses could eat up most of the coverage you have, leaving little to pay any judgment levied against you.
  • Surplus lines. Pay careful attention to policies written through excess and surplus lines. Insurers sometimes use these lines, which are not subject to state regulations, to avoid risks such as terrorism and mold, which some states require them to cover. Your insurance advisor should be able to tell you whether these policies have excluded any other risks. Monitoring the source of the insurance is especially important when you are changing carriers, because you could end up with dangerous coverage gaps of which you aren’t aware.

If you are changing carriers and/or agents, ask the agent to certify in writing what the new policy covers. You want this statement to include an apples-to-apples comparison listing the coverage you had in the old policy, the coverage you are getting in the new policy that you did not have before, and the coverage you had previously that the new policy will not provide.

  • Terrorism insurance. The insurance and real estate industries, among others, were much relieved by the news that Congressional negotiators have resolved the impasse blocking approval of legislation creating a federal terrorism insurance “backstop” that will pay a portion of any future terrorism-related insurance claims.   Final approval of that legislation, more likely now although not completely assured, should make terrorism insurance both more available and more affordable, both for new development projects unable to proceed without the coverage, and for existing buildings in danger of defaulting on mortgages that required coverage owners were either unable to obtain or to afford.
  • Mold coverage. To the chagrin of the real estate industry and individual homeowners, insurance carriers have been successful in limiting mold liability coverage and dramatically reducing mold-related property damage coverage. While these exclusions are based on some very real and legitimate insurance industry concerns, the real estate community must carefully evaluate the new coverages to assess their risks.
  • Earthquake insurance. Massachusetts is not California, but it does sit on the second worst fault line in the U.S. Damage risks are highest for buildings constructed on fill in downtown Boston (a good-sized quake will probably send them into the waters), but some level of coverage is important for all multi-family structures.
  • Fidelity insurance. Community associations are generally aware that they need this insurance against thefts by board members or staff members (the condominium statute requires it), but most don’t have enough coverage and the policies aren’t always structured properly. The insurance should be issued in the association’s name with the property manager obligated under the association’s policy. That will cover a theft by the management company principals as well as by the property manager. The property manager will have coverage through the management company, but that policy typically will cover the property manager only – not a good idea, considering that the largest community association theft on record in Massachusetts, although it occurred many, years was perpetrated by the management company’s owners. Needless to say, that management company hasn’t been in business for years, but the risk of thefts by board members as well as staff is real, and associations need adequate protection from those potential losses.