While insuring your association against potential catastrophes can be a daunting proposition for a board made up of volunteers, it’s a crucial part of the job. Fortunately, there are delineated starting points, ample resources, and industry professionals to which a board can turn for guidance. Nobody likes dwelling on worst-case scenarios, but by allocating its resources in a prudent manner, a board can be proactive in minimizing losses while protecting the best interests of its owners and shareholders.
Let’s start at the beginning: What types of insurance are essential to responsibly operating an association? There’s a magic number at play here, and it is three.
Loretta Worters, VP of communications at the Insurance Information Institute, a New York-based organization that publishes an array of resources dedicated to explaining insurance and enhancing public knowledge about the industry, describes the key coverage types as follows:
1. General Liability – Because an association bears much of the responsibility for maintaining the building and property, it faces significant liability exposure for injuries and damages that occur on the premises. This is why general liability insurance is so crucially important to have—particularly if you have a swimming pool or other high-risk amenities. If someone is injured or the property is damaged as a result of negligence on the part of the association’s leadership, management, or maintenance staff, general liability coverage will pay for any judgments or settlements (up to the policy limits).
It’s incumbent on board leadership to make sure there are adequate liability limits commensurate with the risk profile of an individual amenity. General liability coverage will also pay for the cost to defend the association itself, but not its directors or officers. How much coverage you should have depends on many factors, including the size of the building or development, and types of exposures (pool, tennis court, etc.).
2. Directors & Officers Liability – This protects board members against claims of damage resulting from decisions made by the board. It’s hard enough to get residents to run for and serve on the board as it is—imagine how impossible it would be if board members could be individually sued by any resident claiming to have been negatively impacted by a board decision. ‘D&O,’ as it’s often called, puts a layer of legal protection between board members and potentially litigious residents, but there are conditions for coverage: D&O only covers damages resulting from decisions made in good faith—if funds are mismanaged because of deliberate fraud, or injuries and property damage are caused by negligence, the responsible parties are on their own when it comes time to pay fines, fees, and court costs.
3. Fidelity Coverage – This protects the association in the event that anyone in its employ absconds with money or property, or commits some other serious transgression that ends up costing the HOA. Reserves are accumulated to ensure that there is enough long-term revenue to pay for major capital improvements for the building, like to a roof or an HVAC system. Maintenance and repairs need to be done on a timely, sometimes urgent basis, so if an association’s funds have been misappropriated, that could result in significant assessments to owners. Fidelity coverage pays to reimburse these embezzled monies.
The Less Basics
While being aware of the various insurance options available to your association is certainly important, it’s by no means the extent of the battle. A board must carefully ponder exactly how much of its finances it should allocate toward a policy, assessing all of the variables at play, including the size of the association, number of units, reserve capital, likelihood of an accident, etc. Also, insurance isn’t a one-time purchase; thus a board must be aware as to when, why, and how often it should reevaluate its coverage.
And of course the cost of coverage is a huge factor. A board must find that happy medium between indemnifying itself and not breaking the bank. “In any financial advisory role, the question arises as to what level insurance is required and how much you should buy,” explains Tom Neis, owner of Neis Insurance Agency in Crystal Lake, Illinois. “It’s partially determined by the number of units at your property, but it’s also determined by litigation. I personally suppose that I wouldn’t sit on a board unless it had at least $2-$5 million for protection against any mistake or perceived mistake that a director might make, like, say they bring in a roofing contractor to re-do the condo roof, they opt for the low-cost bid, and it causes them nothing but trouble with leaks and whatnot.”
It’s also important to see that your treasurer is appropriately bonded. “Bonding isn’t that costly,” says Neis. “Let’s say that bonding for $250,000 in your association’s checkbook costs $500. I’d make sure that the association had at least the state minimum, and I’d probably go over the top. I wouldn’t err toward just having directors and officers insurance; I’d make sure that the treasurer is bonded such that the board isn’t held liable in the case that it didn’t place definitive enough guidelines as to how and where money is spent.”
Associations are often focused on penny-pinching, so it helps to frame an insurance purchase in terms of what you may be saving down the line, as opposed to what you’re spending now. “A board can buy an inexpensive $200 or $300 D&O policy,” notes Sean Daly, CPCU, with Affiliated Insurance Managers in Warwick, Rhode Island. “But it’s much more prudent to spend an extra few hundred and get the real policy that automatically includes the property manager as an insured, and gives you full prior acts. Yes, you’re spending several hundred more up front, but you’re potentially protecting yourself from losing literal millions down the line.”
The imperative thing is that a board not be dazzled by the lowest price. “More often than not, boards gravitate toward a bargain, and depend on the seller to tell them what’s covered and isn’t,” says Richard Resnick, a senior account executive with Schechner Lifson Corporation in Summit, New Jersey. “Oftentimes though, a seller sells the board rather than educating them. Only when a board knows precisely what it’s buying can it make an informed decision.”
Different amenities can carry with them a varying degree of risk, and can affect insurance rates accordingly.
According to Resnick, “In an application for insurance, and in an inspection by the insurance company, the insurer will look at all the amenities, and ask various questions along the lines of ‘is there a pool? Does the pool have a lifeguard? Is there a diving board? How about a clubhouse? If so, can you bring guests? Will there be alcohol on the premises?’ and so forth. And this refines the exposure that the underwriter has.”
The association has the option to bring in an outside appraiser to ensure that a potential insurer is assessing an adequate value to each amenity. “It’s a very common thing today to have a variance as to what an amenity is actually worth,” says Neis. “From an insurance standpoint, it’s not what an association paid for an amenity, or what the association thinks that amenity is worth; it’s how much that amenity will cost to rebuild. And those estimates can be off by as much as 50%. Usually, the association will try to argue down how much something is worth, while the insurance company will try to argue up the value. In all likelihood, an association may be unaware as to how expensive something will be to rebuild.”
Rental Tenant Considerations
It’s very common for condo owners (and co-op shareholders as well, but to a much lesser degree) to rent their unit to a tenant as an investment or revenue property. When that happens, there are insurance complications that need to be addressed.
“Let’s say that you own a condominium unit and rent it to me,” posits Paul Kaliades, president of Renters Legal Liability LLC, based in Salt Lake City, Utah. Reaching all branches of the multi-family industry, the company also offers a Condominium Legal Liability program. “If I cause a $25,000 kitchen fire, unfortunately, your HO-6 condominium owner’s insurance policy won’t cover that loss, as you have invalidated the policy by engaging in a commercial endeavor by renting the unit to me. And this can get extreme. Even when there are renting restrictions in an association’s bylaws, they aren’t always heavily policed by the board. So we’ve seen some dramatic problems come up in mid-rise or high-rise buildings, where you have a flood in an upper unit that seeps into four or five neighboring units below, such that you’re talking a $75,000 or $100,000 repair bill. Without protection in place for the renter, you’re in trouble.”
So it’s imperative that a board be aware of the activities and conduct of individual owners within the property. If renting or subletting is taking place, and all involved parties don’t do their due diligence in regard to insurance, everyone involved could face steep penalties in the event of an accident.
Amenities are added or removed, new units are constructed, the façade is altered —residential properties are constantly in flux, and thus may require adjustments to the association’s insurance coverage.
“Every year, I present to my clients a proposal with a summary of their coverages,” says Daly. “And every few years, they may want to compare prices with other insurance companies. If an association is particularly antsy regarding insurance charges or what they pay for reinsurance, we’ll even do comparative shopping annually. But at the very least, it’s always good to do a quick yearly sit-down and a thorough reading-through of your coverage policy. And if there’s construction going on, any relevant effect on insurance warrants more attention.”
Daly’s colleagues concur, but Neis warns against overdoing it with bargain shopping: “The worst case example of prudent directorship is if they go out and price their insurance every year,” he says. “The problem is when you’ve jumped around too much, and then you have that one catastrophe, your carrier is likely to cancel you going forward. As long as you know that the pricing is fair and equitable—and how one determines that is admittedly a good question—it’s better to have a long-term relationship with a carrier. I’d rather have a long-term carrier with whom I can negotiate inspections and replacement analysis reports to make sure that I’m covered properly; that to me is the prudence of a directorship, rather than going out and getting the low price every year. You’re not likely to save money by jumping around.”
Finally, Resnick hammers home the importance of transparency when dealing with an insurance provider: “Misrepresent anything in your application, and shame on you,” he says. “Because you’re buying insurance so that it responds the way that it’s supposed to, should you need it. If the carrier sees that you misrepresented something, they have grounds to decline the claim based on false information. However, if you didn’t falsify anything, and they provided the policy, you have grounds to sue them for what they’d said they’d insure you for. So always tell the insurance provider the gospel. And if you don’t know the answer, be upfront about that.”
Cooper Smith is a staff writer/reporter for New England Condominium.