Not all houses are created equal – and neither are insurance policies.
If you are an investor and you have ever purchased a rehab property using only ‘builder’s risk’ insurance – you’d better continue reading. Few people, including investors and full-time real estate professionals, have any real understanding of what property insurance is, the various coverages used, endorsements, and, most important, exclusions.
First Things First
To begin with, there is no such thing as ‘full coverage’ insurance for anything, especially real property – period. Got that? ‘Full-coverage’ implies that you are completely covered for any act of nature, man, or God, and that is absolutely not true as there are ALWAYS ‘exclusions’ written into any and all policies; 100% of the time, that you are not protected against.
What is an ‘Exclusion’
Exclusions are those items specifically outlined in the details of the policy (in the conveniently apt-named ‘Exclusion’ section) that specifically list what your policy WILL NOT cover or indemnify (reimburse) you for. Items such as war, nuclear explosion, intentional acts, government action, environmental pollution, and several others are pretty standard although each policy differs, not to mention the difference that exists from state to state according the state’s own regulatory insurance laws. It is imperative that you read through these exclusions in order to understand what you are NOT covered for (instead of finding out when it’s too late) and then ‘endorse’ or request any additional coverages that you may desire to be protected against for your own unique situation.
What is an ‘Endorsement’?
An endorsement is an ‘addition to’ or ‘change within’ the policy that affects the coverage that the policy currently contains, whether it is to increase monetary coverage limits, add additional items to be covered, change the type of indemnification from Actual Cash Value (ACV) to replacement cost, and many other items.
Using a homeowner’s policy as a simple example, let’s assume that you own a house with $200,000 property damage coverage for hail, fire, wind, etc. Generally speaking, the contents inside your house such as furniture, bedding, electronics, etc. are usually protected at a default amount of 50% of the property damage coverage limit, which in this case is $200,000, so you would be covered for up to $100,000 for your interior contents so long as they were damaged due to a covered peril (a ‘covered peril’ is one ACTUALLY LISTED in writing your policy as being covered and NOT contained in the ‘exclusions’ section.)
However, if you decided that it would cost you more than $100,000 to replace all of your furniture, clothing, cookware, personal items and so forth (say $125,000), you could add an ‘endorsement’ to change the $100,000 coverage limit that you have by default to $125,000 – you might just have to pay a slight higher annual premium (which varies by company).
Okay, those are the two big insurance terms that we are concerned with at this point, now shall we continue?
Various Types of Policies
As we continue, please know that this article is not going to delve into the various types of policies available for all situations, those are far too complex and that subject is for another article at another time (however, you can always contact InsuranceForInvestors to discuss any and all insurance or asset-protection issues on a personal one-on-one basis – is that a shameless plug or what?)
Without going into umbrella coverage and proper limits of automobile insurance, there are only really two general types of property insurance policies that you should be aware of; Builder’s Risk and Dwelling Policies, and almost every investor that I have worked with has been SEVERELY underinsured (if insured at all) and unaware of their exposure to extreme financial loss (this is what happens when you purchase policies over the phone from a licensed ‘order taker’.)
BUILDER’S RISK POLICIES
A Builder’s Risk policy, which is the type most commonly used by investors, is ONLY for use by contractors performing work (hence the term “Builder”) and many investors are under the dangerously mistaken assumption that this is the only thing that they need to purchase when remodeling or ‘rehabbing’ a property. THIS IS DEAD WRONG.
A builder’s risk policy, unless written through non-standard companies, has NO LIABILITY coverage whatsoever for claims against injury, accident, animal attacks or anything similar and it is only designed to insure buildings and dwellings that are under renovation or construction and to protect any building supplies and tools that are in, on, or within 100 feet of the premises. In other words, you are paying for a policy to protect the contractor’s tools, trailers, building supplies, and materials against loss – and that’s it. He should send you a ‘Thank You’ card at the end of the job. Although some builder’s risk policies cover you against theft, vandalism, and malicious mischief, you are NOT covered against fire, water damage, wind, hail, etc. and you have no protection against lawsuits arising from the personal injury of others that may be injured on your property for any reason. If you are acting as the contractor (by actually working on the property yourself), then this type of policy will protect you against loss of your own tools, equipment, and building materials that are stolen, but you still have no liability and you are wide open to financial and legal loss. Some of the basic features of a builder’s risk policy include:
• Building supplies of the insured (what you paid for) are included in the policy limit;
• Building supplies of others are subject to a $5,000 limit;
• Includes coverage for scaffolding, cribbing, and other temporary structures on-site;
• Contains standard exclusions as do other policies;
• You can insure the full value of the completed building or increase the coverage limits as work increases;
• IMPORTANT: Coverage automatically TERMINATES either 90 days after construction is completed or 60 days after the building is occupied or put to its intended use, whichever comes first.
A Dwelling Policy on the other hand is what most investors actually need – including while the property is being renovated. This type of coverage does contain various limits of liability coverage to help protect you and it is used mainly for rental properties and NOT for homeowners since a homeowner’s policy is used only for insuring a person’s primary residence.
The key features and benefits of a dwelling policy (and there are several types depending upon what perils, ‘endorsements’ and coverage limits you desire) include:
• It contains liability insurance to cover bodily injury and property damage for which you are legally liable and it will pay medical payments incurred within 3 years of an accident (this does not cover the insured <a.k.a. ‘you’> or your tenants, just employees, guests, passers-by, and all others);
• It also contains ‘supplementary payments’ protection at no extra cost (if you chose to accept the liability coverage on the policy). ‘Supplementary payments’ means that you also get:
o Bonds paid with no limit (except up to $250 for bail bonds);
o First aid expenses at the scene of an accident with no limit;
o Interest gained on judgments against you (also with no limit);
o A ‘loss of earnings’ feature to pay you up to $200 per day to assist in defending yourself or investigating a claim;
o Expenses incurred at the request of the insurance company (such as expert witnesses, special investigators, etc that are used when defending you against a claim), and most importantly;
• It covers defense (legal) and investigation costs (with no limit)
In addition, a dwelling policy protects your property against loss arising from any of the ‘covered perils’ listed in the policy such as wind, hail, fire, vandalism and malicious mischief, theft, and several more up to the coverage limit that you choose.
In order to be considered eligible for this type of policy, a property must be only one to four units (SFR to fourplex) and, if a mobile or manufactured home, it must be tied down or permanently affixed by means of having the wheels removed and the tongue cut off.
Again, speaking in general terms about what a dwelling policy covers in regards to property loss, the following bullets are a few standard coverages that are usually included as default amounts in the policy; although each may be increased or changed by adding and endorsement and paying a slightly higher premium:
• ’Other Structures‘ such as sheds, workshops, and detached garages are usually limited to 10% of the coverage that you have on the primary dwelling;
• Personal Property (such as appliances) is also limited to 50% of the limited to 10% of the coverage that you have on the primary dwelling;
• Fair Rental Value (used to reimburse lost rental revenue) is limited to 10% of the coverage that you have on the primary dwelling;
• Loss of Use (used to cover additional living expenses required to allow the household to maintain their normal standard of living) is limited to 20% of the coverage that you have on the primary dwelling.
In summary, you get what you pay for and you need to make sure that you get what you need. The world of property insurance is very confusing and full of misunderstanding due to the many endorsements, exclusions, risks, perils, and other insurance-related terms that are contained within whatever policy your purchase. This is compounded by the fact that so many consumers have been trained to only look at the ‘bottom-line’ premium as opposed to the actual coverage and protection that they are paying for. In addition, people rely on professional agents to provide them with adequate coverage for their own situation, unfortunately however, many agents act as nothing more than licensed over-the-phone order takers less concerned with their customer’s actual needs than they are selling another policy and making their monthly production quota. If your agent has no real-world experience as an investor or business owner and he either cannot or will not sit down with you and explain, in detail, how you are protected against loss (and how you’re not), then you may consider seeking out a professional agent who will work with you so that your best interests are always considered first.