I originally wrote this article over 10 years ago, but it is time to revisit
the topic. In recent years, townhouse/condominium associations have been
choosing higher deductibles on the master policy to keep costs down while
simultaneously shifting responsibility for the entire master policy deductible
to affected individual unit owners. The insurance industry has just responded
with deductible assessment endorsements to the HO 6 policy intended to cover
the unit owner's responsibility for the deductible. In some cases today,
that assessment can be as high as $25,000 or even $50,000.
Today, an owner of a condominium or townhouse is much more likely to have
major insurance gaps in his or her property and liability insurance coverage
than the purchaser of any other personal insurance policy is. There are several
reasons for this.
First, the basic structural coverage of the standard unit owners policy (HO
6) is generally quite inadequate. For starters, the perils covered are the
equivalent of a homeowners form 2—named perils on building and contents.
Typically, the Coverage A structural coverage under the HO 6 policy is just
$1,000. Most unit owners are legally responsible for insuring much more than
that.
Additionally, coverage for loss assessments is inadequate in two ways. This
can be loss assessments that are association-wide, such as those that arise
when a lawsuit for serious injuries ends up in a judgment that exceeds the
association's general liability coverage limit, and the excess is assessed
to all unit owners. This also can include 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 $1,000 of loss assessment coverage. But, even if limits
for loss assessment coverage are increased to, say, $25,000, in most cases,
assessments for deductibles are still only covered for $1,000 under the
increased loss assessment policy endorsement.
Broadening the Perils Covered
The unendorsed HO 6 policy provides named perils coverage only for both
Coverage A structural claims and Coverage C personal property claims. (This is
the unit owner equivalent of a homeowners form 2—a policy rarely sold today
because of its limited coverage.) An agent for a townhouse or condo unit owner
needs to change the perils covered to special perils at least for structural
claims (i.e., HO 3) and probably for personal property claims as well (i.e., HO
5). This 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 all kinds of muddy water onto a unit's
carpeting, hardwood floors, cabinets, furniture, piano, clothing, etc., causing
major damage to these items, the unit owner will have no coverage at all unless
his or her 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
A second reason for the difficulty in setting up an HO 6 policy with
adequate coverage is the difficulty of identifying and measuring the amount of
structural insurance for which the unit owner is responsible. 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
bare floor of the unit. This means that the unit owner is responsible for
insuring all of the items shown in Table 1.
Table 1
Unit Owner Structural Responsibility Items |
Sample.
Replacement Cost Installed |
Carpeting, hardwood floors, ceramic tile, or any other flooring |
$25,000 |
Wall coverings |
$5,000 |
Lighting fixtures |
$5,000 |
Plumbing fixtures (e.g., toilets, tubs, etc.) |
$12,000 |
Built-in appliances |
$5,000 |
Kitchen cabinets |
$20,000 |
Unit owner installed improvements (e.g., screened-in or four-season
porch) |
$30,000 |
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) |
$20,000 |
Total Replacement Cost Installed |
$122,000 |
The installed replacement cost of the items in this particular example is
estimated at $122,000. Clearly, the HO 6 basic coverage of $1,000 is grossly
inadequate.
Discover All Pertinent State Laws
Some states have passed laws limiting how much of a condominium unit
interior a unit owner can be held responsible to insure. In Minnesota, for
example, under the Minnesota Common Interest Ownership Act—Statute
515B.3–113—an association can hold a unit owner responsible for no more than
"ceiling or wall finishing materials, floor coverings, cabinetry, finished
millwork, electrical fixtures, plumbing fixtures, built-in appliances, and all
improvements and betterments to the unit, regardless of when installed."
In Table 1, 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, etc., the law would supersede the added bylaw
requirements, and the unit owner could ignore the value of those items when
estimating his or her Coverage A exposure. [Caution: 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 $1,000—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 $5 million, is destroyed by a tornado and costs
$8 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 $4 million judgment. The association carries $2 million of
liability coverage, resulting in each unit owner being assessed $20,000.
- Heavy rains lead to a massive sewer backup in the complex. Cleanup costs
and repair costs total $75,000. The association board did not purchase sewer
backup coverage, leading to an assessment of $750 to each of the unit
owners.
Under the basic HO 6 policy, with $1,000 loss assessment and named perils
coverage, our hypothetical unit owner will be personally out of pocket for
$29,000 from the tornado assessment, $19,000 from the lawsuit assessment, and
$750 from the sewer backup assessment (not a covered "named
peril").
Because additional loss assessment coverage is so inexpensive, I recommend
always including at least $25,000–$50,000 additional limits with each HO 6.
A fringe benefit of broadening the perils covered is broadening coverage for
loss assessment. Loss assessment coverage applies to those loss assessments
arising out of perils that are 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. Coverage for
sewer and water backup should be added as well, not only because the exposure
otherwise isn't covered but also because, by adding that endorsement, sewer
and water backup coverage is added to the loss assessment perils covered.
Note that if the unit is in an area exposed to the risk of earthquake, and
earthquake coverage is added to the HO-6 policy, most increased loss assessment
endorsements will not include earthquake automatically. The best strategy to
avoid this risk is for the unit owner to strongly lobby the association board
to purchase earthquake coverage on 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 so difficult to set up correctly
is that more and 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 many cases,
insurance companies have been slow to provide a way of covering that increased
deductible assessment. Now, however, most companies 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.
Here are a few examples to illustrate how some insurers are currently
handling the problem in Minnesota.
Table 2
Insurer |
Solution |
Auto-Owners |
Included in loss assessment coverage with a $50,000 maximum |
Chubb |
$10,000 for deductible assessments built into the basic homeowners
contract with additional coverage available |
Cincinnati |
Included in loss assessment coverage with a $25,000 maximum |
Safeco |
Included in loss assessment coverage with a $51,000 maximum |
Travelers |
Included in loss assessment coverage with a $50,000 maximum |
Western National |
Separate deductible assessment coverage as part of the increased loss
assessment endorsement with a $50,000 maximum for deductible
assessments |
Disclaimer: These illustrations are intended to
reflect the huge disparity in the way companies deal with this problem.
Do not rely on this information as being currently accurate. |
Ensure Proper HO 6 Coverage
I recommend the following 10 steps to help agents set up the proper coverage
for their clients, using the HO 6.
- Request a copy of the association "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, unit owner improvements, etc.). (Be sure that
the requirements are permitted by your particular state law.)
- Have your client estimate the replacement cost of each of the structural
items that are his or her responsibility. I find it easier and more accurate
to write out a list of each type of item and have the client
estimate the replacement cost of each category. Total the values.
(Don't forget the labor costs in your estimate.) To be safe, I add an
additional 20 percent 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 to special.
- Add special perils contents coverage (e.g., roof leaks, paint spills,
etc.).
- Increase the loss assessment coverage limits to $50,000.
- Buy deductible assessment coverage. Find out the current master policy
deductible as well as 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 insurance company
you are using does not offer that high of a deductible assessment coverage
limit, change insurance companies.
- 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 (i.e., 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. Lobby your association into
purchasing flood insurance on the complex. Unfortunately, if it fails to do
so, there is no flood insurance deductible assessment coverage
available.
- Buy adequate and consistent liability coverage (i.e., $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. Be sure it includes coverage for association
volunteer activities including nonprofit directors and officers (D&O)
liability coverage in case your client ever serves on the board.
Caution: Because an umbrella policy only covers claims arising out
of bodily injury, property damage, and personal injury, this umbrella
coverage clearly doesn't replace the need for that board to carry D&O
coverage.
Jack Hungelmann's book,
Insurance for Dummies, contains much of this information and is
available at your favorite bookstore or online. For more information on his risk management and
insurance business, go to www.JackHungelmann.com, where you can check out sample
newsletters, brochures, and other articles written on various issues.