Flickr photo credit: MBK (Marjie)

Standard Property insurance forms, unless properly endorsed, specifically exclude monetary losses that arise from the enforcement of building ordinances, building codes, or similar laws.
 
You may have carefully set a 100% Replacement Cost limit on your policy that is adequate to cover inflationary increases, but that “replacement” is to replace your building with “like kind and quality” of design and materials. Upon applying for a building permit to start repairs after a loss, you may be advised you’ll have to:

A. Tear down the undamaged portion of your building; and/or
B. Pay for the cost of that demolition to the undamaged portion; and/or
C. Replace the damaged portion (and the torn-down undamaged portion, if applicable) with construction that meets current codes, including (perhaps) such things as sprinkler and alarm systems, ADA-compliant entryways and facilities, earthquake- or windstorm-resistant construction features, etc.

None of the additional costs of such items are covered by standard, non-endorsed Property insurance forms – regardless of the Replacement Cost limit of insurance you purchased.

Insurance coverage for these items is available (for example, the Insurance Services Office, or “ISO” form that provides coverage is CP 04 05 “Ordinance or Law Coverage”). That form covers the above listed items, and a limit can be selected for each one, Coverage A, Coverage B, and Coverage C (sometimes coverages B and C share the same limit).

Some Property forms automatically include as an “Extension of Coverage”, a modest amount of “Ordinance and Laws” coverage – and often the limits on that coverage can be increased at modest cost.

It is unlikely that your insurance agent or broker has access to the knowledge required to assess your exposure to such losses. Rather, periodic consultation by you with an architect and/or an experienced local builder (or construction industry attorney) may be required. They have the knowledge to advise you, based upon how old your building is and what features it has, as to how much extra you’d have to pay to “build it to code” today or tomorrow; with that information you can talk with your agent or broker about getting proper insurance against this potentially significant exposure.

Photo credit: Flickr Gregor Rohrig

In the last post, we talked about insuring-to-value on a Replacement Cost basis, and about how it is advisable to insure at 100% of RC. We also introduced the concept of Property Coinsurance, which can be thought of as a “quantity discount” that gives you a better rate, provided that the limit of insurance you select meets or exceeds the coinsurance requirements you selected when arranging for your policy. Be aware, though, that to meet the requirements, the limit you select must be adequate at the time of loss – it is not enough to request a limit that is adequate on the first day of the policy.

Here’s an example: let’s say you get a professional property appraisal on your building on October 1, 2009 that says the insurable RC of your building on that date is $1,000,000. Your Property insurance policy renews on January 1, 2010, so that policy will run from 1/1/2010 to 1/1/2011. With that policy, you might be dealing with a loss that occurs on December 31, 2010 – fifteen months after the appraisal. Because your Property Coinsurance clause refers to the RC at the time of loss, if building costs were expected to be inflating at 5% a year, you should have asked for a limit of $1,062,500 (on a 100% coinsurance basis) on your 1/1/2010 renewal, to take care of the actual RC for that 12/31/2010 loss (5% inflation times 1.25 years since the appraisal = a factor of 6.25%).

Building cost inflation factors vary from time to time, and at any given time they will be different in different parts of the country, and they also will vary by type of construction (for example, in the fourth quarter of 2008, building costs for apartment or condo buildings of frame construction might have been 4% higher than a year earlier, while apartments or condo buildings of steel and brick construction might have been 9% higher than a year earlier). Your appraisal company (or your insurance agent or broker) can provide some guidance or advice in these areas as you consider the right limit of insurance to buy.

Even in recessionary times, commodity prices can undergo sharp increases, so one eye should always be kept on the impact of building cost inflation. In times of very high inflation, like we saw some 25 years ago, Property policy limits might need to be adjusted two or three times during the course of the policy year.

photo credit: flickr snapman

These days, most insurance against direct risks of property loss is arranged on a Replacement Cost (or “RC”) basis. The main alternative that is sometimes used is to insure property on an Actual Cash Value (or “ACV”) basis, which is defined as “Replacement Cost (at the time of loss) less Accumulated Physical Depreciation”. ACV insurance may sometimes be the only alternative available, but it should be avoided if at all possible, and understood fully if adopted.

Total losses can, and frequently do, happen. Even a relatively small fire can involve so much smoke damage, and water damage from fire suppression that the cost to make everything right equals the cost to replace the entire building and its contents. A big wind and rain storm can take off a roof, blow out windows, and soak everything so badly that a total loss occurs. One of the basic rules of risk management is “Don’t risk a lot for a little”. If your insurance program is properly designed, you can insure to 100% of your property’s RC at little or no increase in cost over skimping on Property insurance limits.The workings of Property Coinsurance helps control the cost of insuring at full RC. I like to describe Property Coinsurance as a “quantity discount” whereby the insurance company lowers the rate per $100 insured, the closer you get to insuring at 100% of values. As an approximation, the rate applicable to insuring at 100% of RC is 10% less than the rate to insure at 80% of RC. So, if your building could be replaced for $1 million and the 80% rate to insure it was $0.20 per $100, the premium for that $800,000 limit would be $1,600. If instead you elected to insure the full $1 million using 100% coinsurance, the rate would be about 10% lower, or $0.18 per $100 insured and the premium for that $1 million limit would be $1,800… 20% more insurance for just 12.5% more premium. We’ll go a little deeper into the subject of Property Coinsurance in a later blog.

It is uncommon (but not unheard of) for commercial Property insurance policies to provide “Guaranteed Replacement Cost”, which is a coverage enhancement that is sometimes provided by Homeowners insurance companies in their “preferred” or “executive” policies. If you elect 80% coinsurance and insure for $800,000 in the above example, and if there is a total loss, you’re only going to get the $800,000 – which obviously leaves you $200,000 short of the amount needed to rebuild. If your commercial insurance company does offer “Guaranteed Replacement Cost”, you’re paying a bit extra for the feature (and they will be careful to ascertain that you are actually insuring with at least a 100% limit anyway).

Remember, it is you, and not your insurance agent or company, that is responsible for determining the Replacement Cost of your property. RC has nothing to do with what the property originally cost, or its market value, or how it is carried on your books. Rather, RC means what it would cost to actually replace your property on the day the loss occurs. A professional appraisal from time to time would be ideal; or an opinion from a knowledgeable local contractor.

In recent years, with the rising cost of insurance claims and the ambiguous language in some association CC&R’s, insurance coverage has changed dramatically.  Many condominium documents specifically detail what is to be covered – - for example:  roof repair and replacement only.  In this instance, the documents are explicitly pointing out that all other structure is not covered.

A Master Package Policy will generally include property coverage that can be categorized by:

 • Bare walls – coverage for the common elements, usually excludes property within the unit such as interior walls, permanently installed appliances, fixtures, finishings, floors and ceilings  

 • Single entity – coverage for the common elements, usually includes initially installed property in accordance with the association’s original plans and specifications 

 • All in – coverage for the common elements, plus initially installed property, plus improvements and betterments made at the expense of the unit owner

An Association should survey and identify owned property which is to be covered by the association master insurance package:

•  Buildings – residences, clubhouses, garages, carports; Building definition could include foundations, pipes, wires, conduits, utilities, heating, cooling, security systems, machinery and equipment, balconies, porches, decks, and patios 

 • Structures – arbors, awnings, cabanas, sport courts, fences, fountains, gatehouses, gazebos, recreation fixtures. 

 • Other property – could include antennas, indoor/outdoor furnishings, signs, landscaping, fine art.  

 • Non-covered property – could include bridges, roadways, walks, underground infrastructure. 
 

Common causes for the loss of covered property are categorized accordingly:

 • Special form – this is known as an “all risk” form and usually provides coverage for all perils, except those specifically excluded, such as flood, earthquake, war/military action, nuclear reaction  

 • Broad form – this includes loss as a result of fire, lightning, wind, smoke, hail, vandalism, sprinkler leakage, accidental discharge of water, collapse of building 

  • Basic form – most limited coverage of the three types of coverage
 

 In the event of a loss of covered property, the payment of the policyholder will be valued based on: 

• Guaranteed Replacement Cost – replacement cost with no limit and does not state a specific property limit

 • Replacement Cost – payment for the loss is based on the actual replacement and may be limited to stated value

 • Actual Cash Value – loss payments are based on the cost of new product, less depreciation and usage   
 

A deductible will apply to the property insured in the association’s policy.  The deductible could be on an occurrence basis, or could apply separately to each building or unit.  There may be different deductibles for the different covered property. 

One aspect of the deductible to consider is how the deductible will be handled with the unit owner.  Unless the association documents specify who is responsible, the association or the unit owner, then the association should adopt a policy which describes the circumstances under which a unit owner would be responsible for paying the deductible.

It is important that the association Board and its management company understand the scope of the association coverages.  Homeowners should be advised on what is covered.  Even where the association covers improvements, alterations, fixtures and appliances within units, it is advisable for the homeowner to continue to carry coverage on their own separate policy.

For a Master Policy item list that every HOA should review each year, click here

Reprinted with permission © Association Times