At least some readers may recall the confusion that ensued during the comedy routine when Bud Abbott and Lou Costello tried to clarify who was on first base during a baseball game.1
Costello: All I'm trying to find out is what's the guy's name me on first base.
Abbott: No. What is on second base.
Costello: I'm not asking you who's on second.
Abbott: Who's on first.
Costello: One base at a time!
Abbott: Well, don't change the players around.
Costello: I'm not changing nobody!
The confusion that can occur when properly structuring coverage for residential property owned by a "What"—a trust, limited liability corporation (LLC) or other entity—and not a "Who" (a person) is reminiscent of the legendary "Who's on First" routine by Abbott and Costello. For those who have not seen it, here's a link to it on You Tube.
Especially over the past 2 decades, an increasing number of Americans are transferring personal ownership of residential property to trusts, LLCs, limited liability partnerships (LLPs) and other asset-protection or tax-advantaged entities (hereafter collectively referred to as "entity" or "entities"). While transferring real property to an entity can offer a number of benefits, this strategy can also create significant unintended gaps in insurance coverage for the individuals transferring ownership of the property, the entities, those with a fiduciary duty to protect the interests of the entity, and potentially even the professional advisers who have assisted in the transaction.
While all insurance practitioners realize the importance of examining who is regarded as an "insured" by a homeowners policy, many consumers and non-insurance professionals fail to understand that an entity is a "what," and therefore is ineligible to receive coverage as a "you, your, or as a family member" on an unendorsed homeowners policy. This article will provide guidance on the issues and solutions to be considered when structuring coverage to protect all parties with an insurable interest in an entity-owned residential property.
First, Focus on the Right Questions
An LLC, limited partnership, or trust (there are many different trusts) can be formed to own residential property as a means to secure tax advantages, for estate planning purposes, privacy reasons, to shield assets from creditors and litigants, or any combination of these objectives. Insurance underwriters who do not interact with policyholders seem all too comfortable requiring agents and brokers to provide often superfluous details explaining "why" the entity has been structured as it is, rather than focusing on the insurance implications of the arrangement.
The question that has the greatest underwriting impact is actually a simple one: Does the entity that owns the property present any exposure to business-related activities that are not contemplated by the home owners filing? If the answer is yes, risk advisers should understand the need to approach commercial underwriters for a coverage solution to address the property and liability exposures specific to the entities business-related activities. Far more frequently, however, the entity has no intention whatsoever of using the residence for business-related purposes, nor was it formed for any reasons other than to own the personal residence. In the many instances in which an entity owned home is simply intended for use as a personal residence by those individuals for whom it was formed, underwriters and risk advisers should collect answers to the following additional questions to properly assess each risk and help structure coverage that reflects the specific exposure.
Who will occupy the property?
How will the property be used?
In addition to the entity owner, what other parties have an insurable interest, both from a Section I and Section II perspective?
Does the entity own other real property?
Who are the parties to the trust, LLC, LLP, or other entity?
Understanding the Insurable Interests of Who and What
As a reminder, the contract language used in homeowners insurance policies was developed when people, not entities, owned homes. As a result, the definition of named insured was carefully crafted to protect the interests of a very specific group of people. Following is a common definition of who is insured by a homeowners policy.
"Insured means you and residents of your household who are your relatives, or other persons under the age of 21 and in the care of any person mentioned above."
This definition of an insured has been tested many times in court to determine who is and is not eligible to receive the benefits of coverage provided by a homeowners insurance policy. Regardless of the actual ownership interest in the property at the time of loss, there are no known instances in which a court has required an unendorsed homeowners policy to provide coverage to any party other than those defined as insured by the insurance contract.
To avoid potentially disastrous gaps in coverage, proper planning efforts can ensure insurance policies are structured to protect the interests of all parties who have an insurable interest in the event of a property or liability claim. This requires protecting the interests of people and entities, for example: the trust (including those individuals acting as a beneficiary, trustee, grantor), the LLC (and those individuals acting as members), the family limited partnership (FLP) (and those individuals who are managing partners and limited partners), along with the individual(s) who occupy and/or have personal possessions located at the residence.
Protecting the insurable interests of all parties who have a risk of loss connected to an entity-owned personal residence requires careful planning and execution. Consider this example of a claim for which coverage was denied: An extended family owned a large property consisting of 140 acres, which was divided into 15 different sublets. Some of the lots were owned by family members, and others were owned by LLCs controlled by family members. The property was divided for mixed use, and portions of the property were covered by a commercial policy and others by a homeowners insurance policy.
A fatality to an employee of one of the family members occurred on a residential property while the employee was landscaping the property. The LLCs with ownership interests were not listed as named insureds on either the commercial or homeowners policies. Suits were filed against the family and the LLC that owned the property where the injury occurred. Though the family's personal assets were protected by their homeowners policy, they were forced to retain counsel to defend the LLC, as it was not covered by the homeowners policy.
Given the circumstances of the claim, a long period of litigation followed. Assets from both the family who formed the LLC and the LLC (the entity's equity in the property) were required to pay the substantial legal fees and an undisclosed judgment.
Often Overlooked: Section II Implications
As the above referenced claim illustrates, while the very broad liability coverage provided by a homeowners insurance policy serves as a critical form of asset protection, Section II coverage is often overlooked. Homeowners policies not only provide protection against many forms of suits alleging bodily injury or property damage associated with a residence premises, but liability protection is also extended for covered acts arising away from the home. Additionally, regardless of the merits of such legal actions, the liability protection provided by a homeowners policy also obligates the insurer to provide insured parties with a legal defense for covered losses. Naturally, having access to this important coverage depends entirely on how the policy has been structured.
Relative to other causes of loss, liability losses occur with far less frequency than those resulting in damage to the home. Even though liability claims are very infrequent, the costs to settle the few losses that do occur can be extremely high. Insurers find it challenging to underwrite with great certainty the full scope of all entities that own residential property. Additionally, underwriters know the initial objectives for the entity can shift over time to include activities that present an unacceptable exposure.
Consider, for example, the situation in which an entity that owns a residence is named in a lawsuit alleging damages due to an act that occurred far away from the insured location. In this instance, the broad liability coverage provided by a homeowners policy could obligate the insurer to pay defense costs and related damages for a suit it could not possibly have contemplated. Because an entity owner may present a greater exposure to lawsuits than individuals, many insurers are unwilling to provide a homeowners policy offer that includes liability coverage.
Although precise coverage needs can vary widely based on many different factors (especially the use of the residence), the following characteristics outline the risk profile that is most common among residences owned by an entity.
A trust, limited liability company, or limited partnership is formed for the sole purpose of holding title to a family residence.
The family that is benefiting from the entity which owns the residence occupies the home.
The family occupants are closely connected to the entity—as grantors, trustees, and beneficiaries, in the case of a trust, or as managers, general partners, members, or limited partners, in the case of a limited liability company or limited partnership.
The family retains personal ownership of the furnishings and other contents at the home.
The table below identifies the insurable interests of each party for this very common risk profile.
Party with an Insurable Interest:
Coverage Required for:
Entity (Trust, LLC, etc.)
Dwelling: Owned by the Entity Other Structures: Owned by the Entity Premises Liability: Entity Can Be Named in a Suit
Trustee, LLC Member, or Partner of a Limited Partnership
Premises Liability: Can Be Named in a Lawsuit
Beneficiaries (LLC Member) and Individuals Who Are Also Occupants of the Residence
Contents—Owned by Occupants Additional Living Expenses (Loss of Use) Occupants Would Incur Costs To Reside Elsewhere after a Covered Loss Liability—Occupants' Negligence May Cause Them To Be Named in a Suit, Coverage Required for This Location and Elsewhere
Thus far, this article has taken a broad approach in describing how the "insurance industry" regards this coverage issue. Of course, there is no universal industry approach to address the protection needs of residential properties owned by all entities. Even in the case of the common and innocuous risk profile described above, many insurers do not offer adequate coverage for all parties with insurable interests. The endorsement most commonly used by insurers—Residence Held in Trust HO 05 43—covers only a residence held in a trust. The select group of insurers serving financially successful consumers who often reside in homes owned by entities formed for their own benefit—ACE Private Risk Services, AIG Private Client Group, Chubb Group of Companies, and PURE—provide endorsements which can provide coverage for most arrangements that do involve a business-related exposure.
Well-crafted additional insured endorsements serve to protect the property ownership and legal interests of the entity and those serving the entity, while enabling risk advisers to designate the person(s) occupying the home as named insured so they and others who reside with them can benefit from the coverage as their insurable interests require. Other solutions serve to expand the definition of "insured person" to also include entities and those responsible for the activities of the entity concerning the insured location. The key to any endorsement solution is to secure coverage for the dwelling, other structures, contents, additional living expenses and personal liability/medical payments for the individuals and entities that require protection.
Avoid Common Pitfalls
A common but improper approach used to structure coverage for entity-owned residential property is issuing a homeowners policy with the entity as the named insured. Glib "solutions" like this neglect to provide for the protection needs of one or more parties. When naming the entity as the named insured, those residing in the home would have no insurance protection for (a) liability claims filed by third parties, (b) first-party losses to their personal possessions, or (c) additional living expenses should a loss to the residence require them to live elsewhere. Even when the individuals residing in the property are provided protection as an "additional insured," they are ineligible to receive the benefit of coverage for their contents or the additional living expenses they would incur after a covered loss. Another common pitfall is neglecting to add the entity owner as an additional insured party on a personal excess liability or umbrella policy. As with homeowners policies, personal excess liability policies cover individuals, not entities. Thus, coverage for the entity must be properly endorsed so that the entity can receive the benefits of this important form of liability coverage.
For a number of reasons, the growth of residential properties owned by entities is becoming increasingly commonplace, and there are no reasons to believe this will change. In the many instances when the home is being occupied as a traditional residential premises, extending homeowners coverage to protect the interests of the entity owner and occupants need not be as problematic as many insurers make it. Solutions are available from more than a few insurers, but many more need to adopt common-sense solutions to entertain these otherwise traditional home owners' risks.
Underwriters are entirely correct to entertain only those submissions for entities that own homes used as a personal residence by those the entity was formed to benefit. Any business-related activity by the entity, either at the insured location or elsewhere, creates an unacceptable personal insurance exposure and requires risk advisers to approach the property as a commercial risk.
To address the potentially expanded liability exposure presented by an entity, endorsements limiting such coverage for the entity to the residence premises only represent a reasonable underwriting precaution and should not present the entity an uncovered liability exposure. Risk advisers need to identify the parties to the entity, as well as those who will be occupying and furnishing the residence. Further, risk advisers should only work with those insurers that are comfortable entertaining entity-owned residences, and securing coverage solutions that properly protect the insurable interests of all parties involved.
In the event of an uncovered claim, citing the Abbott and Costello routine to explain your confusion in improperly structuring coverage will amuse no one. Avoid assumptions, identify all of the parties requiring protection, and read the insuring agreement and any prescribed endorsements to identify who and what are being afforded which coverage parts.
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1 Portions of this article were previously published in Will State Farm Be There? Often Overlooked Property and Casualty Insurance Aspects of Common Estate Planning Transactions, coauthored by Michael S. Arlein, for The Practical Tax Lawyer (Aug. 2007), published by the American Law Institute.