Insurance Coverage Gaps Are Common for Community Associations and Costly for Owners

Published on: November 21, 2010

Ask an audience of community association board members if their communities are “fully insured,” and you will almost certainly receive a unanimous and confident show of hands. Ask if they have reviewed their insurance policies in recent memory, or have ever read them at all, and the hands will begin to waiver. If participants are honest, the show of hands should all but disappear.

That’s not surprising. Insurance is complicated, dry, and unlikely to be a favorite topic of conversation for anyone, with the possible exception of insurance professionals and their close relatives. As a result, many communities 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?

The Fannie Mae requirement for condominiums (and thus the industry standard) calls for $1 million in general liability coverage. But in a world in which litigation is constant and multi-million-dollar awards have become the norm, a $1 million policy no longer goes very far. It certainly wouldn’t have helped the community forced to pay a $32 million judgment awarded a resident claiming damage from mold, nor would it begin to touch the claim if your building superintendent accidentally runs over and kills a child in your community’s parking lot.

Property damage claims are more common than liability losses, but insurance professionals will tell you that coverage in this area is also inadequate. That is partly because some boards set insured loss caps intentionally too low to reduce their premiums, but it is also because many boards don’t know how the coverage they have matches their community’s needs. What boards don’t know about their coverage can definitely hurt them, as the board of a Massachusetts condominium discovered after their building was destroyed by a fire. When this board filed the association’s 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 fell far short of the amount required to rebuild, and owners had to absorb a $50,000 – $70,000 per unit special assessment to close that gap.

A policy offering “guaranteed replacement cost” coverage (paying whatever it costs to rebuild) would have taken care of the problem. But that coverage, once widely available, is hard to find today. Few carriers offer it and those that do are extremely selective about the communities they will cover. However, most policies do include an automatic inflation adjustment provision, which increases the policy limits annually to reflect increases in area building costs. Boards should make sure their community’s policy includes that inflation trigger and also make sure the cost benchmarks the insurer uses are reasonable. It is also a good idea to have the property appraised periodically – at least every three or four years – to make sure the coverage limits are adequate. Also make 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 should consider, but often don’t, when they are obtaining insurance coverage or renewing existing policies. 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 adviser evaluate the bids you receive, explaining the similarities and the differences and comparing the costs and coverage different companies are offering.

If you aren’t working with an adviser, 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. Many associations have increased their deductibles from the $1,000 that used to the industry norm to $2,500, $5,000 and as much as $10,000. Those that haven’t yet made that adjustment should do so. Higher deductibles will both reduce the association’s premium cost and eliminate the small claims that can trigger future increases and may threaten future coverage. Associations should also amend their by-laws to or adopt a rule requiring unit owners who suffer damage covered by the condominium master policy to pay the association’s deductible – easy for owners to do if they have the deductible coverage that is an inexpensive addition to an owner’s policy. Tapping the owner’s policy first is less costly for the community and makes the master policy do what it is supposed to do – insure the community against catastrophic losses. 

Ordinance or law. Even the scarce but desirable guaranteed replacement cost coverage described earlier won’t pay to bring older structures into conformity with building code requirements adopted after the buildings were constructed. If a building is damaged severely or destroyed, a standard policy might pay the cost of restoring the building to its pre-disaster condition, but it won’t cover the cost of installing sprinklers, adding parking spaces, increasing setbacks, and making other changes an updated building code will require. Association master policies typically exclude losses resulting from “governmental orders”; ordinance or law coverage, which associations can purchase as an endorsement to a standard policy, erases that exclusion and restores the coverage.

Agreed amount endorsement. This coverage eliminates the penalty that would apply if it turns out that your property 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.

Business interruption. If a fire or other disaster forces owners to relocate and temporarily disrupts the collection of common area fees, this insurance would enable the association to continue meeting its financial obligations until its normal income stream is restored.

Fidelity insurance. Community associations are generally aware that they need this insurance against thefts by board members or staff members, but most don’t have enough coverage and their 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. This structure will cover a theft by the management company principals as well as by the property manager. The management company will have its own insurance, but that will typically cover the property manager only – it won’t cover a theft perpetrated (as some have been in the past) by the management company’s owners.

Non-hired auto coverage. Assume that a board member conducting association business accidentally kills someone in an automobile accident. If his/her personal coverage isn’t adequate to cover the claim, the victim’s family can sue the association 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, but all of them need it.

Workers’ compensation. Many boards overlook this coverage, assuming they need it only if the community employs workers directly. But associations without anyone on their payroll may still be vulnerable to claims, for example, if an employee of a contractor the association hired is injured while doing work for the community. If the contractor does not have the appropriate coverage, the laws in many states will make the community liable for 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. Some policies will pay off if you lose a suit, but you will have to pay the litigation costs in the meantime. You want a policy that includes indemnity coverage for the cost of defending actions against you, and you want to make sure the 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. Boards should also be aware that the D&O coverage many companies include as an endorsement in the insurance packages they offer community associations don’t typically cover non-monetary claims (for board election challenges, architectural review decisions, rules enforcement, and the like, which represent the majority of the liability claims most communities are likely to file. A mono-line or stand-alone policy is more expensive, but it will cover these non-monetary claims.

Surplus lines. Watch out for companies writing coverage through “surplus lines,” issued by subsidiaries or affiliates that are headquartered in another state and sometimes in another country. These out-of-state entities aren’t subject to state insurance regulations, which means they don’t have to provide the coverage the state may require. 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.

A few more insurance tips for community association boards: 

  • Be proactive about risk management. The best way to reduce premium costs is to limit the number of claims you file. Use the association’s reserve study to identify risks and quantify exposures. An older roof is more likely to be damaged in a severe storm and so represents a greater risk than a newer one.
  • Shop the community’s insurance periodically to compare the coverage available with the coverage you have.
  • 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.
  • Establish claims management procedures and follow them if your community has a claim. Most policies will specify the steps boards should take after incurring a loss, but it is also a good idea to ask the carrier to specify in writing any additional measures the company requires.
  • Educate owners. Make sure they understand why it is essential for all owners to have individual unit-owners’ policies, and consider adopting a rule requiring owners to demonstrate that they have this coverage.
  • Understand what property the association owns and what property it is responsible for insuring.