Published on: August 20, 2008
Condominium insurance coverage questions are notoriously complicated and often confusing for industry professionals as well as condominium owners and their governing boards. But for owners and insurers in Maryland, this admittedly confusing issue has become bewildering and more than a little unsettling following a state appeals court ruling that homeowner associations are not required to cover casualty losses for individual units under the association’s master policy. As the headline in one newspaper report noted, the decision, which contradicted industry practice nationwide, “turned Maryland condominium insurance upside down.” It got quite a bit of attention nationally in the on-line “chat rooms” of condominium attorneys, as well.
The decision, Diane Anderson, et. al. v. Council of Unit Owners of Gales on Tuckerman Condominium, et. al., combined two cases with similar fact patterns, raising essentially the same question about how condominiums are, or should be, insured. In one, a leaky water heater on the second floor of a two-story townhouse unit damaged the floor below; in the other, a grease fire in the kitchen caused extensive water and smoke damage in that unit. In both cases, the damage was confined to a single unit, was caused by problems originating within the unit, and the damage amount was below the deductible on the master policy. The owners sought to collect under the master policies of their communities, the associations rejected the claims, and the owners and their insurer (the same company for both) sued. Circuit courts ruled against both owners, and the Maryland Appeals Court upheld those decisions, agreeing that the homeowner associations (called councils of owners in Maryland) were required to cover only the common elements in their communities.
The appeals court based its ruling on its interpretation of the language in Maryland’s condominium statute and its analysis of the legislative history of that measure. The plaintiffs in both cased had cited a provision of the law requiring the association to maintain insurance on “the common elements and units, exclusive of improvements and betterments installed in units by unit owners.” But the court noted another provision in the statute making owners responsible for maintaining and repairing their individual units. That language “does not distinguish the duty of an owner to repair in the course of ordinary maintenance from the duty to repair following a casualty loss,” the court said.
The court acknowledged that the statutory language created some ambiguity about the association’s insurance obligations, but the legislative history of the statute, the legislative history of the statute, the court concluded, resolved that ambiguity in favor of the association. To support its conclusion, the court quoted commentary accompanying a revision of the Uniform Condominium Act, on which the Maryland statute is based. The commentary, supporting master policy coverage of individual units, stated: “Given the great interdependence of the unit owners in a stacked unit condominium situation, mandatory property insurance for the entire building is the preferable approach. “ But a footnote also acknowledged a distinction between “stacked units” and other structures. “In town home properties, where no stacked units exist,” the note observed, coverage of individual units “was not contemplated.”
In the court’s view, coverage of individual units also “was not contemplated” by Maryland lawmakers when they enacted the state’s condominium statute. The intent, the court said, was to require community associations to obtain casualty insurance covering damage only to common areas and common elements. “Each owner is not an insured person with respect to his or her individual interest in his or her own property, but rather is insured under the master policy only as to his or their collective undivided interest in the entire condominium property,” the court said in its decision. “Thus, the master policy is meant not to insure each owner’s property or individual unit, but to protect the common interests of all owners as co-owners of the entire condominium.”
Accepting the argument of the owners that the master policy should cover casualty claims restricted to their units, the court said, “would lead to illogical and absurd results, by giving [the association of owners] greater responsibility for losses within a unit than a landlord has on the property of a tenant, when the landlord owners the space, while the council of owners does not.” Had the legislature intended to impose a broader insurance requirement on community associations, the court added, “it could have fashioned the statutory language accordingly.”
That is precisely what state lawmakers are expected to do when the next legislative session begins in January. Between now and then, the state insurance commissioner is urging insurance carriers to meet with homeowner associations to clarify how they will handle claims involving damage to single units under existing policies. In an emergency directive published last month, the state regulator pointed out that while the court ruled that associations are not required to provide coverage for individual units, the decision did not prohibit them from doing so.
“In light of the significant changes brought about by [this decision],” Insurance Commissioner Ralph Tyler said, “it is important that all parties understand the risks to which they are exposed and be offered an opportunity to purchase insurance with adequate limits to protect themselves.”
The court’s unexpected (and widely criticized decision) doesn’t apply anywhere outside of Maryland and it probably won’t apply there for very long. But it does highlight the complexities that can make condominium insurance difficult even for some courts to understand. Certainly the Maryland insurance commissioner’s statement about the need to understand insurance risks and coverage boundaries applies to all community associations, not just to those in Maryland.
Disputes about the insurance obligations of condominium owners and homeowner associations, fairly common at one time, are relatively rare today (with the notable exception of the Maryland dispute), because the industry standard has become either “all-in” or single-entity (original specifications) coverage. All-in casualty policies, the norm for condominiums in Massachusetts, cover damage to individual units, including fixtures, betterments and improvements, and excluding only the owner’s personal property. Single-entity or original specifications policies also provide broad coverage for damage to a unit, but exclude any improvements the owner has made, requiring compensation sufficient only to restore the unit to its “original specifications.”
In the secondary mortgage market, Fannie Mae and Freddie Mac require at least single-entity coverage on condominiums financed by mortgages they purchase, to avoid disputes between insurers over which policy – the master policy or the unit owner’s policy – should pay for repairs or reconstruction following a casualty loss.
Providing all-in or original specification coverage under the master policy also avoids the risk that an owner who lacks adequate insurance will be unable to rebuild after a loss. Having a damaged unit that is not repaired properly or at all could reduce the value of the community as a whole — another argument for providing comprehensive coverage under the master policy, to protect the shared interests of all owners.
In Massachusetts, as in many other states, practitioners have found that all-in coverage – encompassing improvements – is preferable to original specifications, because over time, it is virtually impossible to determine what the original specifications were and what improvements successive owners have made through the years.
Improvements Hard to Track
Condominium documents usually require owners to notify the board of any improvements over a specified dollar limit and give the association the right to assess owners for the increased insurance costs related to those improvements. Owners aren’t very good about complying with that reporting rule, however, and governing boards don’t typically enforce it, because, as a practical matter, the master policy coverage amounts are so high, improvements made by unit owners are unlikely to affect the association’s premium costs. Theoretically, associations could also limit reimbursement to owners who have failed to report improvements, but, again, few take that stance because the insurance typically provides more than adequate coverage for an individual claim.
A more pressing concern for many associations is the failure of owners to obtain coverage for their share of the master policy deductible. For claims involving a single unit, with all-in or single entity coverage, the master policy should cover damage above the deductible amount; when the claim falls below the deductible limit (as was the case in the Maryland litigation described earlier), the unit owner’s policy, subject to a much lower deductible, should cover the claim. Had the Maryland condominium owners obtained deductible coverage, the issue probably would never have been litigated.
But as the Maryland disputes illustrate, owners who lack deductible coverage are distressed, to say the least, when they discover that the association’s master policy will not reimburse them. We advise association boards to adopt insurance resolutions specifying that owners are responsible for the master policy deductible and are required to have deductible coverage. The requirement is difficult to enforce, but being able to point to that language makes it a little easier for boards to deal with irate owners who did not obtain adequate insurance because they assumed the master policy would cover everything.
On the other hand, we don’t think boards should require owners to provide proof of insurance, as some industry executives have suggested. The concern is that adopting a rule of this kind will create an expectation that the association will verify owner insurance, imposing an implicit obligation on the board to do so and creating potential liability for the association if it does not. Boards should educate owners about condominium insurance; they should explain what the master policy covers and what it excludes; and they should remind owners periodically that they need unit owner’s insurance, including deducible coverage. But they should not assume the responsibility for assuring that owners have the insurance they need.