Many people mistakenly assume that a homeowners policy will cover them no matter what the occupancy status of their home is. But secondary homes present a unique set of challenges for owners, insurance agents/brokers, and insurers to contend with when trying to protect them from harm.
Whether it is a weekend getaway, beach house, snowbird retreat, pied-à-terre, or ski chalet, every second home has its own unique characteristics and usage patterns that need to be understood when designing an insurance policy and risk management plan. This article shares many of the issues that make insuring second homes challenging. It will also provide tips on how to mitigate risk at these properties through loss prevention strategies and technology.
Five Areas of Concern
There are five key areas that owners should understand when protecting their second homes.
Insurance company underwriting guidelines
Occupancy Is a Key Driver of Risk
The occupancy of a home refers to who is living in it and how often it is used. For example, an owner-occupied home is occupied most of the time by the owner, and a vacant home is not occupied at all. This risk factor is important for insurance companies to understand because a primary home that is occupied most of the time has a lower probability of experiencing a loss than a secondary home that has intermittent occupancy, tenant or renter occupancy, or is vacant. This is simply because it is much more likely that the warning signs of a possible disaster are identified when someone is present and the home is being used regularly than when it is unoccupied.
AIG Private Client Group conducted a benchmarking study of their "Family Office" clients, who are characterized by their ownership of multiple properties, and found that two-thirds of this client segment has experienced a claim.1
Agents and insurance companies need to be fully aware of the specific occupancy of a home to properly insure it. Each occupancy type requires a different insurance policy type. Many people mistakenly assume that a homeowners policy will cover them no matter what the occupancy status of their home is. To determine how an insurance policy will respond to a claim, the policy language must be fully reviewed and understood. Here is one example of some of the language from the Insurance Services Office, Inc. (ISO), HO-3 homeowners policy that speaks to this issue of occupancy.
Insuring Agreement: "We cover … the dwelling on the 'residence premises' shown in the Declarations…."
Homeowners Definitions: "'Residence premises' means … the one family dwelling where 'you' reside…."2
The most important word in this language is "you." If this language is contained in the policy, it can be used to deny a claim if the insured does not reside at the residence premises. Many people are unaware of this issue and are paying insurance premiums for a policy that will not respond when they need it.
Second Home Occupancy Types
The occupancy type of a second home will depend greatly on the intended use of the property by the owner. There are several different uses for second homes, which are listed below along with the risks that are associated with their occupancy types.
Family vacation homes. Vacation homes are used solely by the family and friends of the owner of the home. These homes are generally occupied a small percentage of the year for vacations. When a vacation home is unoccupied, even a small loss can turn into a major problem because no one is there to identify it.
Investment property. Homes that are purchased as an investment are intended to be sold for a profit. Owners of these homes may spend considerable sums to renovate them prior to selling. These homes are generally unoccupied, under renovation, and for sale during the owner's involvement with them, leaving them open to significant risks.
Long-term rental properties. Long-term rental properties are leased to tenants for months at a time. Leases are typically from 6 to 12 months in duration. When a homeowner rents a property to a tenant, they become a landlord to that tenant with a responsibility to maintain the home to ensure it is safe for the tenant. A dwelling fire policy is the appropriate policy for this type of home.
Short-term rental properties. Short-term rental properties are rented to tenants for a minimum of one night but could be rented for a much longer time frame. The purpose of these properties is to yield a profit for the home owner by renting the property as often as possible throughout the year. This arrangement is classified as a business, and the insurance policy needs to cover the commercial aspects of this type of property.
Homes under major renovation/construction. A second home might be an 1800s farmhouse in need of a major renovation or a custom home built from the ground up. The challenge with insuring these homes is the renovation or construction that will occur prior to the home owner moving in. The major risks to these homes include active construction risks (e.g., power tools, demolition, etc.), it is an unoccupied home/structure during construction, it is an attractive nuisance for passersby that could lead to vandalism or a liability concern, building materials may be left unattended, etc. These situations need special attention with respect to the insurance program.
Insurance Company Underwriting Guidelines
Once the intended use and occupancy of a second home is determined, the next step is identifying an insurance company that can provide a policy to cover the risk. This is sometimes easier said than done. Every insurance company has its own set of rules for what it can and cannot insure. These rules are put in place to help the insurance company mitigate the risk of loss. Here are some characteristics of second homes that insurance companies may review prior to offering terms for a policy.
Availability of water. When a home is over 5 miles from a water source, such as a fire department, fire hydrant, or a cistern, the severity of damage caused by a fire is increased substantially. A home's distance to a fire department along with other geographical factors (e.g., windy roads, gated homes, etc.) will dictate that department's response time during a disaster. The longer it takes for emergency personnel to respond to a loss, the more severe the loss will be.
Location relative to areas known to be susceptible to natural disasters (e.g., flooding, earthquake, wildfire, sink hole, hurricane, tornado, etc.). Homes located in areas known to be highly susceptible to natural disasters, such as on the coast or in earthquake-prone areas, require underwriting attention to ensure the home is adequately protected and is eligible for coverage with the insurance company.
Loss history. Loss history is examined when underwriting a second home. Research into loss data supports the idea that previous claims that occur with some frequency are an indicator of further claims in the future.
Insurance score. A person's insurance score is calculated differently by each insurance company. Insurance companies typically use a person's credit score3 as well as accident and insurance claim history to generate a score. Insurance scores are used for rating policies because research has shown that there is a strong correlation between low insurance scores and claim frequency. Insurance companies may use this information to help them assess and properly rate risks they take on.
Risk balancing. Second homes can bring greater risks than primary homes simply because they are occupied less throughout the year. Some insurance companies can only offer to insure a second home if they are also insuring a primary home due to this increased risk. Collecting premiums for both homes helps the insurance company offset the additional risk posed by the second home. If a second home poses an even greater risk due to its location (i.e., exposed to hurricanes), an insurance company may also request that additional lower risk insurance policies (i.e., automobile, valuable articles, and umbrella) be combined with the home policies to further offset the additional risk the second home presents.
Property Damage Risk from Natural Disasters
Many people choose to purchase their second home in an exotic location: near the beach, in the mountains, near rivers and lakes, or in remote locations. In addition to the picturesque views these properties offer, they may also come with a high exposure to natural disaster or catastrophe risk. Ocean front properties face the risk of flooding and wind damage caused by high winds and hurricanes every year. Homes located in arid climates are exposed to wildfire activity during periodic droughts, and properties near a fault line may be damaged when an earthquake strikes.
The important thing to understand when purchasing a second home that is exposed to natural disaster or catastrophe risk is that special insurance will need to be purchased to cover these risks. For example, a home near the beach may need a separate policy to cover wind and flood damage. A home located near a fault line may need a separate policy to cover earthquake damage. These coverages will add to the cost of the insurance plan but are critical to the home's protection.
Liability Risk at Second Homes
Liability insurance provides an important protection for home owners. This protection will pay legal defense costs and damages awarded by lawsuits brought on by an injury or property damage caused by some negligence. Second homes carry significant liability risks that could relate to swimming pools and spas, outdoor sport courts, and tenants or renters. Whatever the exposures are for a second home, they need to be considered in the underwriting and policy design process to ensure proper coverage is in place.
Risk Management for Second Homes
Once a policy is designed, the final step is to incorporate intelligent risk management strategies and technologies to help predict, prevent, and mitigate potential future losses.
Risk Management Strategies
Here is a quick overview of some of the strategies and technologies that are being used to protect second homes.
Hire a property management company to monitor and preserve the property.
Turn off the main shutoff valve for the water when the home is not in use.
Be wary of social media posts that indicate a property is unoccupied.
Ensure all doors and windows are closed and locked when the home is not in use.
Risk Management Technologies
The following table has some technologies that can be used to manage risk to a second home.
Automatic Water Shutoff Valve
This device will monitor the water usage in the home and automatically shut the water to the home off if it identifies a problem.
Leak Defense Systems, Flo by Moen, FloLogic, Phyn
Whole House Standby Generator
This device will ensure power continuity during a power outage.
Lightning Protection System
This device will protect your home from lightning strikes that may impact a home.
EMP Defense (EMPdefense.us)
This device will provide early warnings and active monitoring of smoke, motion, and temperature fluctuations in a home.
ADT, SimpliSafe, Nest, Ring
Fire Suppression System
This device will protect a home from fire by detecting fire in a home and then spraying water directly at a fire once identified.
Insuring secondary homes can be a complex process. It takes a clear understanding of the property characteristics and insurance company guidelines to deliver a well-crafted insurance program. Working with an insurance agent/broker who specializes in insuring second homes is the best way to ensure the second home is properly protected.
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.
2019 Family Office Benchmarking Study, AIG Private Client Group, 2019. In addition, research insights about risk management technologies and tools are provided by AIG Private Client Group's risk management department.