Why is Vacation Rental Property So Hard to Insure?

by Kelly Troy on March 6th, 2012

"Insurance" and Vacation Properties Don't Always Fit Together...

Why is it so hard to find insurance for my vacation or short term rental property?”

I hear this question a lot.  Because of that, I thought that answering it first would be the best place to start with this new article series about insuring short-term and vacation rentals.  However, be prepared as this article is very thorough and it’s a loooong answer to a short question.  There, I said it – you’ve been warned.

To begin with, insuring short-term and vacation properties is tricky – and it requires some specialized and not-too-common insurance knowledge to make sure it’s done right as protecting these properties and their respective owners is not as easy as issuing a simple homeowner’s policy.  From the perspective of the consumer it shouldn’t be a big deal, after all, it’s just another rental house, right?

Uh, wrong…

Yes, it’s true that the physical property itself hasn’t really changed regardless of whether it’s owner-occupied, occupied by a full-time tenant with an annual lease, or rented on weekends and holidays to vacationers.  However, the exposure that the property represents to the insurance company changes significantly with each scenario.  Therein lies the problem.  You see, contrary to popular belief, insurance companies (despite all of their advertising and rhetoric) actually don’t like insuring things that they consider to be ‘high risk’ or ‘outside the norm’.  They (like all businesses) want to make as much money as possible while losing as little as possible at the same time. Knowing this, they can’t accurately predict losses on vacation property because, quite simply, none of them really understand it and they have never made a study as to the profitability versus losses in this market. The most common (but certainly not all) reasons that insurers refuse to issue coverage for short-term and vacation rentals are listed below.

THE PHYSICAL PROPERTY – Part I (Tenant Damage) – Although the property itself hasn’t changed, with vacation rentals the insuring company’s exposure to a physical loss at the property increases exponentially. We’ve all heard the cliché “never purchase a used rental car”, right? The reason is simple, human nature tends to allow people to treat items that they don’t own and have responsibility for maintaining differently than similar items that they do own and maintain themselves. The same holds true whether it is a rental car or a rental home.  We’ve also all heard of individuals renting luxurious hotel suites and doing thousands of dollars’ worth of damage for absolutely no reason other than because they simply thought it was fun.  Behaviors change, especially when people are out vacation to have a good time and when they are staying in property that is either much more comfortable and higher-end than their own residence or when they are staying in areas that foster poor behavior (such as downtown areas in metropolitan cities where tenant travel to attend festivals and enjoy the ‘night life’).  Because of this, short-term and vacation rental properties have a much higher propensity to suffer ‘tenant caused damage’ than does an annually-occupied rental property which the tenant occupies as a primary residence and for which he or she may have to worry about eviction, the loss of a deposit (which most vacationers simply consider part of the cost of their vacation) and/or the inability to obtain a future rental home because of a bad rental reference. Full-time tenants, generally speaking, have more to lose by being bad tenants than does someone renting a property for four days never to be heard from again.

THE PHYSICAL PROPERTY – Part II (Location) – In addition, unlike most tenant-occupied properties that exist in average urban areas and built-out neighborhoods near fire hydrants, fire stations, and emergency services; short-term and vacation property often present an entirely different risk.  Few, if any, vacationers are looking to spend $400 a night renting a home in downtown Abilene, Texas. However, there are numerous short-term tenants seeking vacation rentals in the mountains near ski lodges, in coastal areas near the beach, or in thriving metropolitan areas such as downtown Manhattan or Los Angeles where property values are very high. In each of these scenarios, the geographic location is a big factor as described in the five most common considerations listed below.

A. ISO / PPC Fire Protection ClassThis is one of the biggest initial considerations for property insurers. Before we go too far, “ISO” stands for “Insurance Services Office” and “PPC” stands for “Public Protection Classification”.  It is important to understand both of these terms in order to understand how they relate to insuring vacation property. ISO is the national ‘think tank’ for the insurance industry, providing risk analysis data, policy forms, and other insurance-related services and products too numerous to mention. All insurance companies use ISO. Without going into its history beginning in the early 1900’s, ISO’s Public Protection Classification (PPC) gauges the fire protection capability of local fire departments to respond to structure fires in virtually all areas of the country. The three primary rating criteria used in making this determination include Fire Alarms1, Engine Companies2, and the community’s Water Supply3.  ISO analyzes the relevant data mentioned above and then assigns a numerical Public Protection Classification (PPC) ranging from 1 to 10.  Class 1 represents superior fire protection (the best) and Class 10 (the worst) indicates that the area’s fire-suppression program does not meet ISO’s minimum criteria. The higher the PPC class number the greater the risk of loss by fire, therefore; the greater the risk to the insurance company and the higher the insurance premium. Classes 9 and 10 are considered “Unprotected” and most insurers will not issue coverage for any property located in a PPC 9 or 10 area at all. Unfortunately, these two ‘unprotected’ areas are exactly where many vacation rental properties are located by virtue of the fact that they are in the mountains, on the coast, or otherwise outside of urbanized or municipal areas.

1 How well the fire department receives fire alarms and dispatches fire-fighting resources, evaluation of the communications center, number of operators at the center, the available telephone service and the number of telephone lines coming into the center, the listing of emergency numbers in the telephone book. Field representatives also look at the dispatch circuits and how the center notifies firefighters about the location of the emergency.

2 The number of engine companies and the amount of water a given community needs to fight a fire, the distribution of fire companies throughout the area, training of fire personnel, how often the company checks or tests its pumps and regularly inventories its nozzles, hoses, breathing apparatus, and other equipment.

3 This focuses on whether the community has sufficient water supply for fire suppression beyond daily maximum consumption. Issues evaluated include pumps, storage, and filtration and to determine the rate of flow the water mains provide, fire-flow tests are conducted in the community and the distribution of fire hydrants is taken into consideration.

B. Wind Exposure – Like the PPC classifications just described, there are many areas of the country, where many vacation properties are located, that have a high exposure to loss by windstorm or hurricane. Obvious examples include Florida, Alabama, Mississippi, Louisiana, and the Gulf Coast of Texas. Because of this, many property insurers issue coverage for the physical structure but specifically exclude in writing any coverage whatsoever for wind-related losses.  In these areas, property owners must purchase a separate ‘wind policy’ from the State’s authorized ‘wind risk pool’.  The policies are often expensive (depending upon the desired coverage amount) and there is little or no ability to shop for better rates – it’s literally a ‘take it or leave it’ decision.

C. Brush / Fire Exposure – Just like the wind coverage just described, it is common for vacation properties, especially those in California, to be located in ‘brush areas’ which present a high likelihood to loss by uncontrolled brush fires due to the large amount of dry tinder available as a fuel source as well as the coastal winds which further fuel the flames and cause these random fires to spread quickly, engulfing large areas and causing tremendous insurance losses.

D. Flood Exposure – No different than the wind and brush fire exposures previously addressed, many vacation properties also have a higher-than-average exposure to flood damage, whether through tidal surges or floods (coastal homes) or floods caused by rising lake levels or rivers breaching their banks.  Flood coverage is not included in standard property policies. An individual flood insurance policy must be purchased in addition to the actual property policy (and/or wind policy) and the maximum coverage limit is usually $250,000 for the structure and $100,000 for contents. If more coverage is needed, an ‘excess flood’ policy will also be required (think of this like an ‘umbrella policy’ for flood damage).

E. Coastal Exposure – Properties located in coastal areas present a mixture of risks for most property insurers – (1) the potential for increased mold claims due to high humidity, (2) damage due to windstorm / hurricane, (3) flood damage, (4) unique and unacceptable construction conditions such as home on raised piers or stilts.

THE PHYSICAL PROPERTY – PART III (Construction and Risk Characteristics) – Again, not to beleaguer the point, but insurance companies by and large all want to insure properties that are similar in nature and present an average or below-average risk of loss. However, many properties have unique architecture or construction features which, aside and apart from any other issues, also make them completely ‘unacceptable’ and outside of the ‘appetite’ for almost all insurance companies. Without going into great detail as to ‘why’, some of the most common ineligible property characteristics include (but are certainly not limited to):

  • Solid Log Construction
  • EIFS Exterior (Exterior Insulation Finishing System)
  • Raised-Stilt construction (examples are raised coastal properties)
  • Properties built on steep grades with varying foundations (part slab / part stilts, etc)
  • Properties located on more than five acres
  • Properties with liability exposures such as boat docks
  • “Unprotected” properties in PPC 9 and 10 areas
  • Properties with a high number of past losses
  • Homes with complicated roof lines and large roof areas
  • ANY historical property
  • Any property with a solid-fuel heating device (such as antique wood-burning stoves like many cabins have)
  • Properties with wooden shake roof
  • Properties that are not easily visible to neighbors
  • Properties with custom or unique architecture, such a three story homes or art-deco construction

THE PROPERTY’S RECONSTRUCTION COST – In addition to the five geographic considerations that we just mentioned, many vacation properties also have replacement or reconstruction values that exceed $500,000 and often $1,000,000 or more. Because most personal property insurance companies are in the business of issuing coverage for standard homes that present ‘average’ risk, these values often exceed the company’s coverage threshold that most insurers have in place (most are up to $500,000 per property with some going up to a maximum of $1,000,000). Properties exceeding this amount are ‘unacceptable’ to most insurers regardless of the PPC class or any other factors.

THE OWNERSHIP STRUCTURE – The ownership structure of the property is also an issue with regards to who is the ‘Named Insured’ policy owner. Common ‘in the box’ insurance companies will almost never issue a policy in the name of a corporation or LLC even though that may be how the property is titled. From the perspective of these companies, any property titled in any name other than (sometimes) a Trust or an individual’s name is automatically considered to be a commercial property – regardless of whether that is actually true or not. Therefore, if the vacation property is in a LLC or company name, that one issue alone will prohibit most insurers from issuing coverage.

OCCUPANCY This is also one of the biggest issues for insurers and their primary reason for denying coverage. Homeowner Policies are intended for owner-occupied residences that are occupied by the primary owner on a regular basis.  This includes policies for second-homes that are not rented out to others at any time. These policies specifically prohibit rental to tenants and/or boarders during the term of the policy.  However, many property owners have exactly this type of policy in place – which probably means they really aren’t insured at all even though they may be paying premiums.  Dwelling policies are normally intended to insure non-owner occupied residences owned by the insured but rented to others – but only if they are rental on a full-time basis to the same tenant.  With regards to vacation property, there is no single ‘full-time tenant’ in place and the short-term occupancy directly violates the underwriting and eligibility guidelines for the insurance carrier.

LIABILITY EXPOSURE – This is another big issue. The term ‘liability’ is often (and incorrectly) used as an all-encompassing term that is assumed to mean ‘all liability risks’. This is a very dangerous interpretation of the word and there are three very specific types of liability that you as a rental property owner should be aware of.  Unfortunately, in most cases, only premises liability is included in insurance policies for non-owner occupied property – which means you as the property owner often have no liability protection whatsoever for ‘personal liability’ issues.

Premises Liability – As just mentioned, this is the first of the three types of primary liability that vacation property owners (or any landlord) should be concerned with. It’s also usually the only type of liability included in dwelling policies. Premises liability is a liability coverage included in most dwelling policies which protects against legal and medical costs for premises-related issues such as bodily injury and property damage.  Examples of these types of claims might be a guest who is injured because a deck railing breaks when leaned against and causes him or her to fall and sustain an injury. Another example might be a guest who slips in a porcelain or steel bathtub and sustains injuries and then pursues legal action claiming that the property owner had not properly installed non-slip traction strips or a grab handle. With regards to someone else’s property being damaged or destroyed due to the vacation property itself, consider what would happen if the vacation home were to catch fire and burn, thereby destroying the guest’s clothing, luggage, and other personal belongings as well as destroying his or her vacation and creating additional expenses.  Another very real claim would be a large branch from an established tree which hangs over the driveway.  If this branch were to unexpectedly break and fall onto the guest’s vehicle – which is parked in this driveway – the property owner would be responsible for all damages to the vehicle and/or any damaged personal property inside.  Premises liability does not cover the property owner for issues such as invasion of privacy, wrongful eviction, libel, slander, or other such issues.

Personal LiabilityPersonal liability is the second type of liability that all landlords should be concerned with – and it’s also the one seldom included in dwelling policies. Unlike premises liability, personal liability is the coverage necessary to provide protection against legal and settlement costs associated with personal torts such as the invasion of privacy, wrongful eviction, libel, slander, and other similar issues.  Obtaining this coverage often requires a second type of liability policy aside and apart from the original property insurance.

Animal LiabilityAnimal liability is very seldom discussed and almost never thought about – until it’s needed (and not there).  This is very important for property owners who allow their guests to brings pets with them, such as those vacationers renting lakeside property or mountain cabins and bringing their large-breed dogs with them to in order to play outside and enjoy the outdoors. It doesn’t sound like much, but what happens if and when that animal – who is unfamiliar with the environment and/or any nearby neighbors – attacks a neighbor or his or her child that happens to be outside? What if the animal attacks another neighbor’s pet or livestock?  This is a very real liability issue that insurers take into consideration and which most property owner’s never even think about.

EXTENDED VACANCIES – Lastly, most insurers won’t offer coverage for short-term or vacation rental properties due to the fact that they are concerned with unknown vacancies. When a typical rental property goes vacant, it is usually in an urban area and there is normally another tenant in place within a month or so and the property is maintained and made ready for the new tenant.  However, vacation properties may be located in remote areas outside of the city limits and the insurance company really has no way to judge how long periods of vacancy will last. Properties in ski areas may be vacant for six months until the ski season comes back around. The same is true for beachfront property which may be unoccupied for long periods of time during cooler weather or during hurricane season.  Because of this, insurance companies run the risk of unaddressed maintenance issues turning into very expensive claims due to the fact that the property was vacant and no one was around to remediate potential problems such as leaking faucets or pipes which may leak for weeks or months before being discovered. There are also concerns regarding weatherization and properties not properly being weatherized prior to vacancy in cold weather.  Theft and vandalism are also concerns.

In summary, properly insuring vacation and short-term rental properties requires a specific knowledge of insurance as well as markets willing to take a risk on insuring these types of properties.  Our company understands this market very well and we are experts at insuring all types of vacation property in numerous areas across the country.  If you would would like us to develop a proposal for your short-term rental property, simply complete the vacation property form below and either fax it to (512) 692-2631 or email it to info@insuranceforinvestors.com.

Vacation Property Form

Kelly Troy

ABOUT THE AUTHOR: Kelly Troy is founder and President of InsuranceForInvestors.com as well as an active real estate investor himself, purchasing and ‘rehabbing’ both residential and commercial properties and actively engaging in non-traditional investing throughout the United States. As the founder of “STREETSMARTinvesting” as well as the developer of the “Riches in Rehabs” and “Riches in Rentals” investor programs; he has traveled extensively to host workshops and impart to other investors and real estate professionals the same principals and skills that he himself has learned regarding how to successfully profit from purchasing real estate. Kelly also established his own successful real-estate investor’s group and he is a frequent guest speaker at other REI groups and he often hosts local investing workshops in addition to teaching TREC-approved MCE courses for licensed real estate professionals. Kelly is also a combat veteran of the United States Army Infantry as well as an active member of his community, serving on several City and Regulatory Boards and having either Chaired or actively served on the Board of Directors for many professional and community organizations. In addition, after having spent several years as a traditional mortgage lender, he founded his own private-lending firm, Genesis Funding Solutions, and he was a hard-money lender underwriting and managing private loans to investors for projects of all types across the country. He is also extremely well-versed in all forms of seller-financing and in brokering privately-held mortgage notes. Prior to his investing career, Kelly was also a professional safety and risk consultant having developed many safety and risk management programs in various industries and he traveled frequently developing and implementing industrial and manufacturing processes, safety, and quality assurance programs throughout both the United States and Europe. He also worked for the Texas Worker’s Compensation Commission (TWCC) as well as the OSHA Consultation Program (OSHCON) as an Industrial Hygienist and he is; therefore, extremely familiar with risk management and loss mitigation, personal liability, worker’s compensation, and commercial risks. While having owned a previous agency with Farmer’s Insurance Group, he was chosen from over 150 agents as the President of the graduating class at the University of Farmers in Los Angeles, California and he was later recognized as one of the Top 25 commercial agents in Texas.

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