An owner of a condominium or townhouse is much more likely to have major insurance gaps in their property and liability insurance coverage than the purchaser of any other personal insurance policy is. Several reasons account for this concern.
The basic structural coverage of the Insurance Services Office, Inc., Homeowners Policy Unit Owners Form 6 (HO 6) is generally inadequate. For starters, the perils covered are the equivalent of a Homeowners Policy Broad Form 2 (HO 2)—named perils on building and contents. Typically, the Coverage A structural coverage under the HO 6 policy is just $5,000. Most unit owners are legally responsible for insuring much more than that.
Additionally, coverage for loss assessments is inadequate in two ways. First, there may be loss assessments that are association-wide, such as those that arise when a lawsuit for serious injuries results in a judgment that exceeds the association's general liability coverage limit and the excess is assessed to all unit owners. Second, there may be loss assessments made against specific unit owners when a loss is caused by the unit owner's negligence, such as a kitchen fire, and the entire association master policy property insurance deductible is assessed against that unit owner. An HO 6 policy usually comes with only $2,000 of loss assessment coverage. However, this limit may be increased via the Supplemental Loss Assessment Coverage (HO 04 35) endorsement.
Broadening the Perils Covered
The unendorsed HO 6 policy provides only named-perils coverage for both Coverage A structural claims and Coverage C personal property claims. (This is the unit owner equivalent of a Homeowners Policy Broad Form 2 (HO 2)—a policy rarely sold today because of its limited coverage.) An agent for a townhouse or condo unit owner needs to expand the covered perils to special perils at least for structural claims (i.e., Homeowners Policy Special Form 3 (HO 3)) and probably for personal property claims as well (i.e., Homeowners Policy Comprehensive Form 5 (HO 5)). This expansion is especially important in an association because the unit owner cannot directly control the exterior maintenance. So, for example, if the older roof in need of replacing leaks muddy water onto a unit and damages the carpeting, hardwood floors, cabinets, furniture, piano, and clothing, the unit owner will have no coverage at all unless their agent had upgraded the perils covered. ("Water damage from roof leaks" is not one of the "named perils," nor is it an excluded peril under the "special perils" form.)
Measuring the Interior Structural Risk
Another reason for the difficulty in setting up an HO 6 policy with adequate coverage is the challenge of identifying and measuring the amount of structural insurance for which the unit owner is responsible, and the homeowners association insures the majority of the structure of each unit. The unit owner is responsible for insuring just the part of the structural interior not covered by the master policy, as spelled out in association documents (typically the "declaration" rather than the "bylaws") and any pertinent state laws. The most common language in a declaration document is that the unit owner is responsible for everything inside the bare walls and the bare floor of the unit. This means that the unit owner is responsible for insuring all of the items shown in the "Unit Owner's Responsibilities for Structural Items Replacement and Costs" table.
Table 1. Unit Owner's Responsibilities for Structural Items Replacement and Costs
Unit Owner's Structural Responsibility Items
Sample: Replacement Cost Installed
Carpeting, hardwood floors, ceramic tile, or any other flooring
$50,000
Wall coverings
$10,000
Lighting fixtures
$4,000
Plumbing fixtures (e.g., toilets or tubs)
$16,000
Built-in appliances
$6,000
Kitchen cabinets
$30,000
Unit owner installed improvements (e.g., screened-in or four-season porch)
$40,000
Any other improvements made to the unit by all previous owners (usually very difficult to determine, especially for an older unit with several previous owners)
$40,000
Total Replacement Cost Installed
$196,000
The installed replacement cost of the items in this particular example is nearly $200,000. Clearly, the HO 6 basic coverage of $5,000 is grossly inadequate.
Discover All Pertinent State Laws
Some states have passed laws limiting how much of a condominium unit interior that a unit owner can be held responsible for insuring. For example, under the Minnesota Common Interest Ownership Act (Statute 515B.3–113) an association in Minnesota can hold a unit owner responsible for no more than "(i) ceiling or wall finishing materials, (ii) finished flooring, (iii) cabinetry, (iv) finished millwork, (v) electrical, heating, ventilating, and air conditioning equipment, and plumbing fixtures serving a single unit, (vi) built-in appliances, or other improvements and betterments, regardless of when installed." In the "Unit Owner's Responsibilities for Structural Items Replacement and Costs" table, each responsibility is within the law. But, if there were other requirements, such as responsibility for interior non-load-bearing walls, wiring within the walls, and related items, the law would supersede the added bylaw requirements, and the unit owner could ignore the value of those items when estimating their Coverage A exposure.
Some older townhouse associations are exempt from the law, so make sure the association is covered by the law before relying on its requirements.
Measuring the Loss Assessment Exposure
Another shortcoming of the basic HO 6 policy is the minimal amount of coverage—usually $2,000—for assessments made against all unit owners for uninsured or underinsured property or liability claims. Three examples, assuming 100 units in the association, follow.
The complex, insured for $10 million, is destroyed by a tornado and costs $13 million to rebuild. The $3 million shortfall would be assessed to the 100 unit owners—that is, $30,000 each.
A drowning occurs at the complex swimming pool. A lawsuit ensues, resulting in a $7 million judgment. The association carries $5 million of liability coverage, resulting in each unit owner being assessed $20,000.
Heavy rains lead to a sewer backup in the complex; cleanup costs and repair costs total $120,000. The association board did not purchase sewer backup coverage, leading to an assessment of $1,200 to each of the unit owners.
Under the basic HO 6 policy, with $2,000 loss assessment and named-perils coverage, our hypothetical unit owner will be personally out of pocket for $28,000 from the tornado assessment, $18,000 from the lawsuit assessment, and $1,200 from the sewer backup assessment (not a covered "named peril").
Because additional loss assessment coverage is so inexpensive, a solid recommendation is to add $50,000–$100,000 additional limits with each HO 6.
A fringe benefit of expanding the perils covered is broadening coverage for loss assessment; loss assessment coverage applies to loss assessments arising from perils covered by the particular unit owner's HO 6 policy. When the coverage is broadened to special perils, the perils covered under the loss assessment optional coverage are also broadened. In addition, coverage for sewer and water backup losses should be added, not only because the exposure otherwise is not covered but also because, by adding that endorsement, sewer and water backup coverage is added to the loss assessment perils.
Note that if the unit is in an area exposed to earthquakes, and earthquake coverage is added to the HO 6 policy, most increased loss assessment endorsements will not automatically include earthquake coverage. The best strategy to cover this risk is for the unit owner to strongly lobby the association board to purchase earthquake coverage for all of the structures and buy earthquake loss assessment coverage.
Covering a Unit Owner's Responsibility for the Master Policy Deductible
Yet another reason why the HO 6 policy is difficult to set up correctly is that more associations have changed their rules so that the master policy deductibles are no longer always assessed association-wide against all unit owners but rather are assessed against an affected individual unit or units. With significantly rising insurance costs for association master policies in the past few years, more associations have gone to higher deductibles of typically $5,000 or $10,000, but in some cases, even $50,000.
The problem with those higher deductibles for a specific unit owner is that if the loss is caused by the negligence of a unit owner, such as a bathtub that overflows or a kitchen grease fire, the association deductible can be the sole responsibility of the negligent unit owner. Unfortunately, in some cases, insurers have not amended their policy forms to cover that increased deductible. Some insurers have developed a specific endorsement that the unit owner can purchase to cover the full amount of the deductible assessment, or they have amended their loss assessment increased coverage endorsement to include deductible assessments against individual units.
Ensure Proper HO 6 Coverage
The following 10 steps are recommended to help agents set up the proper HO 6 coverage for their clients.
Request a copy of the association's "declaration" document. Make a list of building items not covered by the master policy (e.g., carpet, hardwood floors, tile floors, kitchen cabinets, plumbing and electrical fixtures, built-in appliances, and unit owner improvements). (Be sure that your particular state law permits these requirements. )
Have your client estimate the replacement cost of each of the structural items that are their responsibility. It may be easier and more accurate to write out a list of each type of item and have the client estimate the replacement cost for each category. (See the "Unit Owner's Responsibilities for Structural Items Replacement and Costs" table.) Total the values. (Remember to include labor costs in your estimate.) To be safe, an additional 20 percent may be added to the total to allow for estimating errors. That total should be the limit for Coverage A building coverage on your HO 6 policy.
Add "special perils" coverage to Coverage A, changing perils covered from "named perils" to "all risk" unless excluded. This is important for three reasons: It covers more losses (e.g., water damage to walls and ceiling from roof leaks); it improves coverage for losses subject to the master policy deductible; and it changes the perils covered by loss assessment coverage from named perils to special.
Add special perils contents coverage (e.g., roof leaks and paint spills).
Increase the loss assessment coverage limits to $50,000 or $100,000.
Buy deductible assessment coverage. Find out the current master policy deductible and the maximum deductible authorized in the declaration. Choose the higher (so that your client is protected when the association decides to raise the deductible to the next level). If the insurer you are using does not offer that high a deductible assessment coverage limit, change insurers.
Add sewer backup coverage to provide coverage for the direct damage to the unit or contents from sewer backup and sump pump failure and to broaden loss assessment coverage to include assessments for sewer backup. Without this, loss assessment coverage only covers assessments for perils covered by the HO 6 policy.
Assess the need for flood or earthquake coverage. If there is an exposure to earthquake, remember to add earthquake loss assessment coverage, which normally is not included in general assessment coverage. If there is a flood exposure, buy flood insurance for an amount high enough to cover your interior structural insurance obligations, and make sure to lobby your association to purchase flood insurance for the complex. Unfortunately, if it fails to do so, there is no flood insurance deductible assessment coverage available.
Buy adequate and consistent liability coverage (e.g., $500,000) in limits equal to your client's other personal liability coverages or in limits high enough to satisfy the umbrella underlying insurance requirements.
Buy an umbrella policy, and be sure that it includes coverage for association volunteer activities that include nonprofit directors and officers (D&O) liability coverage in case your client ever serves on the board of the homeowners association.
Because an umbrella policy only covers claims arising out of bodily injury, property damage, and personal injury, this umbrella coverage clearly does not replace the need for the board to carry D&O liability coverage.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.
An owner of a condominium or townhouse is much more likely to have major insurance gaps in their property and liability insurance coverage than the purchaser of any other personal insurance policy is. Several reasons account for this concern.
The basic structural coverage of the Insurance Services Office, Inc., Homeowners Policy Unit Owners Form 6 (HO 6) is generally inadequate. For starters, the perils covered are the equivalent of a Homeowners Policy Broad Form 2 (HO 2)—named perils on building and contents. Typically, the Coverage A structural coverage under the HO 6 policy is just $5,000. Most unit owners are legally responsible for insuring much more than that.
Additionally, coverage for loss assessments is inadequate in two ways. First, there may be loss assessments that are association-wide, such as those that arise when a lawsuit for serious injuries results in a judgment that exceeds the association's general liability coverage limit and the excess is assessed to all unit owners. Second, there may be loss assessments made against specific unit owners when a loss is caused by the unit owner's negligence, such as a kitchen fire, and the entire association master policy property insurance deductible is assessed against that unit owner. An HO 6 policy usually comes with only $2,000 of loss assessment coverage. However, this limit may be increased via the Supplemental Loss Assessment Coverage (HO 04 35) endorsement.
Broadening the Perils Covered
The unendorsed HO 6 policy provides only named-perils coverage for both Coverage A structural claims and Coverage C personal property claims. (This is the unit owner equivalent of a Homeowners Policy Broad Form 2 (HO 2)—a policy rarely sold today because of its limited coverage.) An agent for a townhouse or condo unit owner needs to expand the covered perils to special perils at least for structural claims (i.e., Homeowners Policy Special Form 3 (HO 3)) and probably for personal property claims as well (i.e., Homeowners Policy Comprehensive Form 5 (HO 5)). This expansion is especially important in an association because the unit owner cannot directly control the exterior maintenance. So, for example, if the older roof in need of replacing leaks muddy water onto a unit and damages the carpeting, hardwood floors, cabinets, furniture, piano, and clothing, the unit owner will have no coverage at all unless their agent had upgraded the perils covered. ("Water damage from roof leaks" is not one of the "named perils," nor is it an excluded peril under the "special perils" form.)
Measuring the Interior Structural Risk
Another reason for the difficulty in setting up an HO 6 policy with adequate coverage is the challenge of identifying and measuring the amount of structural insurance for which the unit owner is responsible, and the homeowners association insures the majority of the structure of each unit. The unit owner is responsible for insuring just the part of the structural interior not covered by the master policy, as spelled out in association documents (typically the "declaration" rather than the "bylaws") and any pertinent state laws. The most common language in a declaration document is that the unit owner is responsible for everything inside the bare walls and the bare floor of the unit. This means that the unit owner is responsible for insuring all of the items shown in the "Unit Owner's Responsibilities for Structural Items Replacement and Costs" table.
The installed replacement cost of the items in this particular example is nearly $200,000. Clearly, the HO 6 basic coverage of $5,000 is grossly inadequate.
Discover All Pertinent State Laws
Some states have passed laws limiting how much of a condominium unit interior that a unit owner can be held responsible for insuring. For example, under the Minnesota Common Interest Ownership Act (Statute 515B.3–113) an association in Minnesota can hold a unit owner responsible for no more than "(i) ceiling or wall finishing materials, (ii) finished flooring, (iii) cabinetry, (iv) finished millwork, (v) electrical, heating, ventilating, and air conditioning equipment, and plumbing fixtures serving a single unit, (vi) built-in appliances, or other improvements and betterments, regardless of when installed." In the "Unit Owner's Responsibilities for Structural Items Replacement and Costs" table, each responsibility is within the law. But, if there were other requirements, such as responsibility for interior non-load-bearing walls, wiring within the walls, and related items, the law would supersede the added bylaw requirements, and the unit owner could ignore the value of those items when estimating their Coverage A exposure.
Some older townhouse associations are exempt from the law, so make sure the association is covered by the law before relying on its requirements.
Measuring the Loss Assessment Exposure
Another shortcoming of the basic HO 6 policy is the minimal amount of coverage—usually $2,000—for assessments made against all unit owners for uninsured or underinsured property or liability claims. Three examples, assuming 100 units in the association, follow.
Under the basic HO 6 policy, with $2,000 loss assessment and named-perils coverage, our hypothetical unit owner will be personally out of pocket for $28,000 from the tornado assessment, $18,000 from the lawsuit assessment, and $1,200 from the sewer backup assessment (not a covered "named peril").
Because additional loss assessment coverage is so inexpensive, a solid recommendation is to add $50,000–$100,000 additional limits with each HO 6.
A fringe benefit of expanding the perils covered is broadening coverage for loss assessment; loss assessment coverage applies to loss assessments arising from perils covered by the particular unit owner's HO 6 policy. When the coverage is broadened to special perils, the perils covered under the loss assessment optional coverage are also broadened. In addition, coverage for sewer and water backup losses should be added, not only because the exposure otherwise is not covered but also because, by adding that endorsement, sewer and water backup coverage is added to the loss assessment perils.
Note that if the unit is in an area exposed to earthquakes, and earthquake coverage is added to the HO 6 policy, most increased loss assessment endorsements will not automatically include earthquake coverage. The best strategy to cover this risk is for the unit owner to strongly lobby the association board to purchase earthquake coverage for all of the structures and buy earthquake loss assessment coverage.
Covering a Unit Owner's Responsibility for the Master Policy Deductible
Yet another reason why the HO 6 policy is difficult to set up correctly is that more associations have changed their rules so that the master policy deductibles are no longer always assessed association-wide against all unit owners but rather are assessed against an affected individual unit or units. With significantly rising insurance costs for association master policies in the past few years, more associations have gone to higher deductibles of typically $5,000 or $10,000, but in some cases, even $50,000.
The problem with those higher deductibles for a specific unit owner is that if the loss is caused by the negligence of a unit owner, such as a bathtub that overflows or a kitchen grease fire, the association deductible can be the sole responsibility of the negligent unit owner. Unfortunately, in some cases, insurers have not amended their policy forms to cover that increased deductible. Some insurers have developed a specific endorsement that the unit owner can purchase to cover the full amount of the deductible assessment, or they have amended their loss assessment increased coverage endorsement to include deductible assessments against individual units.
Ensure Proper HO 6 Coverage
The following 10 steps are recommended to help agents set up the proper HO 6 coverage for their clients.
Because an umbrella policy only covers claims arising out of bodily injury, property damage, and personal injury, this umbrella coverage clearly does not replace the need for the board to carry D&O liability coverage.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.