So you’re a landlord and you maintain strong leases and good tenant-screenings - what’s the worst that could happen? How about being sued for renting a haunted house? Are liability suits arising from alleged paranormal activity covered in YOUR dwelling policy?
While most property owners are familiar with typical exposures such as bodily injury, invasion, or privacy, and wrongful eviction (which themselves are not even covered in most landlord dwelling policies because they are ‘personal’ injury issues), this is one of the more unusual and interesting liability issues that we at InsuranceForInvestors.com have seen in a while and we thought it was worth sharing just to prove the point that any property owner can be sued for virtually any perceived wrong. You don’t have to be guilty to be accused - but you must still pay legal costs to defend your innocence…
Read the Actual Story Below from CBS New York:
TOMS RIVER, N.J. (CBS New York) – Nighttime is fright time for a Toms River couple who claim the house they rented is haunted.
Jose Chinchilla and his fiancée Michele Callan say they hear eerie noises, that lights flicker, doors slam and a spectral presence tugs on their bed sheets. The couple even called in investigators with the Shore Paranormal Research Society. The group classified the activity as “paranormal” but that it did not indicate a haunting, according to their website.
Chinchilla and Callan are suing the landlord for their $2,250 security deposit claiming the paranormal activity forced them out of the home only a week after moving in. However, the landlord believes the couple was actually spooked by the $1,500 a month rental fee and made up the ghost story to get out of their lease. The landlord has filed a counter suit against the couple. A hearing is expected at the end of this month.
Read Original Story
As someone who writes prolifically about real estate and insurance, this article, as compared to others I have written, is relatively short, however, given some of the recent conversations I have had with investors and some of the recent classes I have taught, I feel it is necessary.
Unfortunately, insurance as a whole is normally viewed by consumers as a commodity or a ‘necessary evil’ that must be obtained when purchasing property and it is usually quoted and purchased with little or no actual knowledge of the policy itself on either the part of the buyer or even the agent providing it.
Because of this, as well as the nature of insurance law, the lack of professional knowledge had by many agents, and the many confusing semantics used within the insurance industry, there is a great deal of confusion between such terms as “Additional Insured”, “Additional Interest”, “Mortgagee”, “Loss Payee”, and “Named Insured” and they are used interchangeably as if they all mean the same thing – BUT THEY DON’T! Unfortunately, this confusion can result in unintended financial loss and unnecessary litigation far into the future and long after the policy has been first issued. All it takes is one claim or loss for the parties in the policy to find out how they really are, or are not, protected and that words actually matter.
For example, when working with investors and non-standard types of insurance situations, it is inevitable that the party requesting the insurance coverage asks to have someone else (usually the seller in a seller-financed transaction) inappropriately listed as an “Additional Insured” on the policy without understanding what he or she is really asking for. What the purchaser (and “Additional Insured Party”) fails to realize is that this provides absolutely no protection whatsoever for the party listed as the “Additional Insured” with regards to the physical property in the event of a physical or financial loss.
The purpose of this article is to finally, in real-life language, explain the difference in these terms so that you, the real estate professional and/or investor, are able to appropriately protect yourself and your interest in any property being insured, whether via wrap-around mortgage, traditional lending, or any other purchase scenario.
The term “Named Insured” refers to the owner of the insurance policy and it is the party listed on the Declaration’s Page. The “Named Insured” is the only party that has authority to make any policy changes, file claims, receive refunds and claim payments, cancel the policy, or make any other such modifications.
In addition, the Named Insured MUST have a primary insurable interest in the property and be the titled owner.
This is probably the single most misunderstood insurance term that is misused and misapplied on a regular basis. An “Additional Insured” is a party listed on an insurance policy that has some type of liability interest in the property. The “Additional Insured” has absolutely no right or authority to make any policy changes or to cancel the policy. Also, contrary to popular belief, an “Additional Insured” is ONLY afforded liability protection under the liability portion of the policy and there is no coverage whatsoever for physical losses resulting from such things as vandalism, theft, fire, wind and hail, and so on.
For example, with regards to residential property, if a property were seller-financed and the seller was actually carrying back a mortgage note and they were listed as an “Additional Insured” on the policy instead of as a mortgagee (described further below), then in the event of a physical loss (the home burned to the ground), the seller would have absolutely no legal right whatsoever under the policy to receive claim funds to pay off the mortgage debt and/or there would be no control of managing claim funds to ensure repairs.
However, if there was litigation involving the property or its use and the “Additional Insured” was named in the suit for any reason, the policy provides liability protection for legal and defense costs for the “Additional Insured” and the insurance company issuing the coverage would have a ‘duty to defend’ any and all “Additional Insured parties” listed in the policy. The most common example of this actually involves commercial policies, such as general liability, whereby a general contractor, for instance, may be listed as an “Additional Insured” on a subcontractor’s insurance so that in the event of a liability claim caused by the subcontractor (such as faulty work, property damage, or bodily injury) where the general contractor is also listed in the suit or claim, he or she receives coverage for legal and defense costs from the subcontractor’s policy.
Many buyers and sellers in a wrap-around mortgage transaction prefer to have the seller listed as an “Additional Insured” rather than as a “Mortgagee” simply because they don’t want to blatantly alert the underlying lender that there has been a transfer of the property. The unintended consequence of this, however, is that the coverages and protections afforded to the seller (who is technically a second mortgagee) are greatly reduced and limited now to liability protection only.
An “Additional Interest” is nothing like the “Additional Insured” though they sound similar. An “Additional Interest” is a party listed in an insurance policy that has an “interest” in being notified whenever a policy cancels or has a major change made to it. In other words, this party is simply being made aware of the change – nothing else. There is absolutely no coverage whatsoever afforded to an Additional Interest. An example of a party who may need to be listed as an “Additional Interest” is a loan servicing company who is managing the loan for a seller-financed transaction. The servicing company has no insurable interest in the property and has no coverage under the terms of the policy, but it does have an interest in being notified if or when the policy is canceled so that it may contact the mortgagee and either have the policy reinstated or request updated proof of any new replacement policy.
It is important to understand that Mortgaee’s and Additional Insured’s automatically get notifications of all policy cancellations and/or major changes and that only other parties associated with the loan in some capacity (but have no insurable interest) should be listed as “Additional Interests”.
The “Loss Payee” is another very misunderstood term which is most often associated with automobile loans – though it is very applicable to commercial and residential property as well. In regards to insurance, a “Loss Payee” (which automatically includes any mortgagee) is the party (or parties) to which any payment being made under the policy in relation to a claim or loss will be made before being released directly to the Named Insured.
For example, assume that you own a property for which “XYZ Bank” is the mortgagee. A kitchen fire occurs in this property and a claim is filed for the damage, which is estimated to be at $85,000. When the insurance company releases the $85,000 claim check, it should be made out to both you (the Named Insured policy owner) as well as XYZ Bank (as the mortgagee and loss payee). This means that XYZ Bank must verify the claim and then endorse the check over to you – or the contractors performing repairs – before it may be cashed. The reason for this is simple; XYZ Bank has a financial interest in the property via the mortgage loan and they want to make certain that they maintain control of the loss payment to ensure that the loan is either paid off (in the event that repairs are not performed) or that the money does in fact go towards repairing the property that is collateralizing their loan – and not to paying for your upcoming ‘around the world’ vacation.
So far we have described the difference between an Named Insured, Additional Insured, Additional Interest, and a Loss Payee; now let’s discuss the true meaning of what a “Mortgagee” really is.
A “Mortgagee” is the entity that actually originates and holds the Promissory Note and Mortgage loan on real property; otherwise known as the bank or the mortgage lender. The Mortgagee extends financing to the “Mortgagor” – who is the homeowner or borrower in the transaction.
By default, all Mortgagees listed in an insurance policy are also automatically considered as “Loss Payees”, meaning that, as in the section above, any claim payments should theoretically be made to both the Named Insured as well as every Mortgagee listed. If a party who has made a mortgage loan to the Named Insured is not listed in the policy, whether intentionally or unintentionally, then that Mortgagee will not be afforded any rights or coverages under the terms of the policy itself.
As you can see, there is a big legal difference between these terms and having an interest listed incorrectly can have unintended and far-reaching consequences in the event of a loss, default, or other such situation. Your agent should know the difference between these five terms, however, the reality is that the vast majority of licensed agents are salespeople with quotas to meet and they seldom, if ever, deal with investor-related transactions and therefore often don’t know the difference between these coverage position themselves. If you have any questions or would like to discuss your own insurance needs, please feel free to call us at (800) 299-8994 or email us at firstname.lastname@example.org
Are you an investor who owns short-term vacation or rental property? Or, are you a homeowner with a nice home located near an area of interest that you lease out periodically for vacationers or weekend travelers looking for a three-day getaway? If so, this question is for you: “What’s the difference between a rental home occupied by a full time tenant and another home occupied by multiple tenants, each for a short period of time?“
From an insurance perspective, A LOT.
Also (get ready), as you read this article, there is probably a 90% or better chance that you are completely and totally uninsured – regardless of how long you have been paying insurance premiums, how much you have paid, or who your insurance company is. You might as well paint a bull’s eye on your back and hang a sign above your door that simply says “Sue Me Here”. You are at serious risk for a denied claim or litigation brought against you (without liability coverage to pay legal defenses) and you probably don’t even know it.
Concerned yet? If not, you should be.
The impetus of my writing this article is due to the fact that I recently came across this very situation and, as an insurance professional who understands the ‘big picture’ of how small issues become large court cases, I was appalled at what I found.
In order to appreciate the information contained later in this article, as it pertains to you as a reader, investor, and/or insurance consumer, you need to understand the issues that I was required to correct for this client in order to put things into context with your own situation.
As a brief overview, I met with a client who is a very successful, sincere, and trusting individual who had, through years of talent and hard work, acquired a large estate and a respectable net worth. This client lives in (as an owner-occupant) a very custom and high-value 8,000 square foot home in a very desirable area of Central Texas, complete with steel framing, marble floors, multiple kitchens and baths, a very expensive roof, and even a full multi-floor elevator. In addition, this individual had an estimated $1M of personal contents in the property, including an estimated $300,000 or more of original artwork. Because of the location, construction, and condition of this home, the bottom floor (approximately 3,500 square feet) was regularly leased out between three days and a week at a time, at an average cost of $600 per night, to ‘weekenders’ looking for a luxurious mini-vacation or others looking for a wonderful place to stay for a short period of time. Needless to say, this was a very custom and very high-value home requiring very specializing underwriting and insurance considerations regarding personal liability, business liability (due to the type of rental), ‘innkeeper’ liability, personal property and scheduled contents, etc. In addition, this individual owned at least two more high-value properties of similar types which were also used for similar investment purposes. In summary, this was a very special situation requiring very specialized and tailored coverage designed specifically for this client’s property types, business, and personal liability risks.
As an insurance consumer and someone who does not work in the insurance industry, the client is obviously not expected to be an expert in all-things insurance-related and he, like many people, had simply relied on his agent to be a professional and do what was in his best interest and properly insure the property and guard his liability exposure.
Unfortunately, the prior agent had either not taken the time to understand this client’s situation and he/she was primarily concerned with selling a few policies to earn a healthy commission and meet this ‘well advertised’ company’s sales quota or he/she had little or no real knowledge of the insurance industry and had no concern for the risk that this individual faced. Regardless of the reasons, at the end of the day, all of the homes were simply insured with standard homeowner and dwelling policies designed for typical ‘main street’ homes. Not only were these absolutely the incorrect types of policies, but the client was, for all intent and purposes, completely uninsured the entire time – and had been for years because even the agent prior to the one mentioned above had done exactly the same thing. This only came to light when the insured had to finally file a large property claim and the problems began.
To begin with, standard homeowner policies (which are designed for owner-occupied residences and second homes) are not intended in any shape, form, or fashion to provide coverage for extremely high-value homes, those with unique construction attributes, homes with large amounts of personal property or large amounts of scheduled items, and those with special liability risks or business exposures (which the short-term rentals are is considered to be). Although these policies vary greatly from one insurance company to the next, the fact is that they are generally designed for typical ‘main street’ homes with typical property and liability risks that a typical owner or family would have (even though most of these are improperly quoted and issued as well, but that’s another topic for another article).
Just a few of the many obvious features of these homes that blatantly violated each and every ‘standard’ insurance company’s underwriting guidelines included:
- Short-term rental exposure (this alone prevents placement in a ‘standard’ insurance market)
This item, in and of itself, is a blatant violation of the underwriting guidelines for all ‘standard’ homeowner’s insurance policies. From an insurance perspective, this is considered to be the same type of exposure or risk as faced by a bed and breakfast or hotel/motel due to the continual turnover of tenants and occupancy status. This alone takes these properties out of the realm ‘personal insurance’ and places them into the ‘commercial’ insurance market. The fact that the home may also be occupied by the owner is irrelevant.
- Some of the homes are vacant for an extended period between tenants.
Standard companies will not write any insurance at all on a property that is currently vacant or which is expected to be vacant for any extended period of time (over 30 days). Many of these homes have vacancy periods in the ‘off season’ and coverage automatically ceases or is severely limited due to the ‘vacancy clause’ contained in the policy wording.
- High-Value home with customized construction features that prevent the proper reconstruction costs with a traditional homeowner’s policy
Standard replacement cost estimators for ‘main street homes’ do not allow the input of custom features such as type of framing (ie: steel stud), flooring (Class-A marble), copper roofing, etc. In addition, these policies have limits on the amount of coverage available for a home as well as the contents it contains. These are often inadequate for this type of risk.
- In-house elevator or exterior tram
These are special liability risks which, more often than not, violate the company’s underwriting guidelines and risk ‘appetite’
- Value of personal contents and scheduled items
The value of personal property and scheduled items, which are higher-than-average with these types of high-value properties, exceed the coverage amounts allowed in the company’s underwriting guidelines. In addition, theft is sometimes excluded and there are very, very low policy limits for items such as jewelry, firearms, artwork, furs, etc. This leaves the client woefully underinsured and open to large losses.
In addition, some of the very real risks that the insured faced included:
- NO LIABILITY COVERAGE
Because the home/risk was improperly issued as has already been made clear, the client has no liability protection whatsoever. This is due to the short-term rental exposure and the fact that it violates carrier policy guidelines. This means that if the insured were liable for a claim (animal injury, personal injury, bodily injury on premises), the company would probably find that there is no coverage for any legal or defense costs. In addition, there is absolutely no coverage whatsoever for the liability exposure faced from leasing to tenants. If anyone leasing the property were injured (drinking on the deck, injured near the boat dock, animal bite, slipping on slick floor, etc), the property owner and his or her assets are completely at risk with no insurance protection to pay legal fees, medical bills, or settlement costs.
- No ‘Innkeeper’ Coverage
In addition to the lack of liability protection just mentioned, the property owner, in a situation such as this, also has full liability for the personal belongings of the individual(s) leasing the property in the event that they are stolen or damaged while on the client’s property. This is no different than if you were staying at a hotel or resort which was burglarized or which caught fire and destroyed your camera, clothing etc. The hotel or resort would have the legal responsibility for indemnifying you for your loss. Regular personal liability does not protect you against this liability, a specialized type of coverage known as ‘innkeeper’s liability’ is necessary to guard against this risk.
Most of these items mentioned above could be considered a ‘material misrepresentation’ on the insurance contract due to the fact that this information, if known, would have prevented the company from issuing coverage in the first place. Whether the omission of this information was intentional or unintentional is irrelevant. An insurance company isn’t going to willingly pay a $300,000 claim on a policy that should have never been issued in the first place and which clearly violated their written guidelines.
Not only were these homes insured improperly with the wrong type of insurance policy, but no consideration had been given to the coverage of the contents, including the high-value artwork and other property. This had simply been ignored by the agent or he/she had no idea of how to insure it – so it was simply left uninsured.
If you are an investor or a property owner in a similar situation, the first two things you should do are:
Read your current existing policy. If it is a typical homeowner’s policy (regardless of the company), you are probably uninsured or you could face severe legal or claim challenges in the event of a loss. Also, find out if you are insured for your scheduled items and if the reconstruction cost of your property has been accurately calculated using the correct physical features and custom items associated with the property.
Contact Your Agent. If he seems unaware of what you are talking about, he is unfamiliar with this type of risk, or he is unsure of his answers and seems to lack knowledge regarding commercial coverage or high-value property insurance; find another agent. These types of property risks need specialized coverage for the exposure they present and few agents are experienced in this area of insurance.
In many cases, situations like the one described above need to be insured as either a Bed and Breakfast or a Hotel / Motel risk. Although the property may be residential in nature and construction, and though it may seem to you (and many ‘personal’ agents) to be something that requires regular home insurance, from an insurance perspective, it is anything but residential – and you are running a great risk in the event of any unforeseen event that results in a claim or litigation.
If you have questions or would like to know more, call us at (800) 299-8994 or email us at email@example.com and we’ll be happy to help you better understand your own insurance situation and find the solutions that best fit your own specific needs.
RELATED ARTICLES OF INTEREST
Getting Past the ‘Sticker Shock’ of Short-Term Rental Insurance
Examples of Claims Related to Short-Term Rentals
FAQ’s: Short-Term Rental Insurance
WHAT YOU DON’T KNOW CAN HURT YOU.
As an investor, especially a commercial buyer or general contractor, there are some things you should definitely be aware of regarding your liability insurance. The same holds true if you are a licensed Realtor or mortgage professional with Errors and Omissions coverage.
When purchasing an insurance policy, especially general and professional liability, there are two different types of policy forms to choose from; ‘Occurrence’ and ‘Claims-Made’. While as a consumer you may have never heard of either of these insurance terms, they can have a huge impact on how (or even if) you are covered when a loss occurs.
‘Occurrence’ forms cover losses that happen (occur) during the time that the policy itself is actually in force. The loss can be reported months or years later after you have switched companies or the policy is no longer in effect, the key is when the loss actually happened. If it occurred while the policy is in force, when it is actually reported in the future is irrelevant. Occurrence forms, in the opinion of this author, are more valuable because they respond to claims brought about years later.
A ‘claims-made’ policy differs in that it only covers claims that are made while the policy is in force. For example, if a ‘claims-made’ policy expired on February 1st and a claim was submitted for work performed on January 1st, there is no coverage because it was made outside of the policy’s effective term.
As the name indicates, ‘claims-made’ policies provide coverage only for those claims made during the time the policy is in force. These policies provide coverage only so long as you continue to pay premiums for the initial policy and any subsequent renewals. Once premiums stop, the coverage also stops for any claims not known or made to the insurance company during the coverage period. What this means is that there is a risk of an unknown or unreported claim being made long after the policy period expires and it not being covered because the claim was made outside of the coverage period.
As you may imagine, moving from one type of policy to the other can be difficult – and dangerous. A claims-made form is okay is the right situations, but it has no guarantee of continued insurability, so if you are, for some reason, cancelled by an insurance company or you decide to shop prices and you switch to another policy to save money, you may not have coverage in the future for work or activities performed in the past. Some important aspects of ‘claims-made’ policies that you should be aware of include:
• the retrospective date;
• extended reporting periods, also known as ‘tail’ coverage (explained below).
If you do move from one insurer to the next with ‘claims-made’ coverage, you must (should) purchase tail coverage or your new insurer must (should) include a prior acts endorsement. With this endorsement, the new insurer assumes coverage for the prior acts occurring in the other carrier’s coverage period. Generally speaking, ‘claims-made’ policies usually cost less than an ‘occurrence-form’ policy, but you run the risk of not being covered for a potential claim because you didn’t discover it until after your policy expired. As with all other aspects of insurance, the decision is a gamble or calculated risk that you as the insured party must make, and you will usually pay a higher premium in order to lower your risk.
‘Tail coverage’, which may cost more if you want to purchase it, picks up where a claims-made policy leaves off, covering occurrences that happened while the policy was effective, but claimed after the policy expired. As a result, the combination of a claims-made policy and tail coverage looks very much like an occurrence policy, with one critical difference. When an occurrence policy expires, the premiums stop while the coverage (on occurrences that happen during the policy period) continues indefinitely. Tail coverage, on the other hand, is something you purchase after your claims-made policy expires, and you continue to pay for it until you decide that the risk of discovering an old occurrence no longer outweighs the cost of the tail coverage premium.
Full tail coverage (which can sometimes be up to 200% of the policy’s original annual premium) is essential when you retire from business or when you change insurers or policies. When changing insurers, you must carefully consider the ‘true cost’ of cheaper coverage (due to its limited exposure) against the other cost of purchasing “tail” coverage from your old carrier.
Basic ‘tail coverage’ is sometimes free of charge but covers only those claims that have been reported during the policy period or 60 to 90 days thereafter and while the original limit is not yet exhausted. Supplemental ‘tail coverage’ must be purchased to cover claims that were not reported during this period. Both coverages apply only to claims stemming from injuries or damage that occurred during the policy period back to the retroactive date. It does not cover claims that occurred prior to such date, nor those occurring after the policy expires.
To put it more simply, the cost of an ‘occurrence’ policy is higher, but fixed, whereas the cost of a claims-made/tail coverage combination is initially lower, but of longer duration and potentially of higher total cost. The decision of which to buy effectively hinges on the nature of your perceived risks.
If your business or work is such that any liability is immediately apparent – and thus claimable – you are probably safe with a claims-made policy. However, if your potential liability can go undetected for a long period of time, such as with a company that pours residential foundations which may fail three years in the future, then you may be best served with an occurrence policy.
‘Occurrence’ coverage, as’ already mentioned, is insurance that provides coverage for the act when it occurs – regardless of when it is reported. If you had coverage under an occurrence policy in 2005 and the claim is reported today (the foundation dropped, improper wiring caused a fire, etc) then the claim is covered.
‘Claims-Made’ versus ‘Occurrence’ – Which Policy Type Should You Choose?
To most insurance consumers, especially those concerned with only the price alone, this whole topic can be more than a little confusing. In an effort to simplify the decision-making process of which policy type is right for you, you should look at the major differences below.
• Premium Cost – ‘Claims-made’ policies are often much less expensive than ‘occurrence-based’ policies. The premium difference can be negligible or, depending upon the carrier, it may be as much as 50% or more.
• Coverage Amount – Under an occurrence policy, coverage is the amount of coverage under the policy in the year of the occurrence. So, if you were just starting out in business or you were trying to save money and you opted for only $100,000 of coverage versus the standard $1,000,000 used by most policies, you may be under-insured against a claim (and legal fees) arising in the future for you work or activities performed in the past. A ‘claims-made’ policy covers you at the level of insurance you have when the claim is made.
• Long Term Cost – If you begin with a ‘claims-made’ policy from the start, it may be cheaper in the long-term if you maintain this claims-made coverage from now on as you may save a great deal in annual premium each year over an ‘occurrence’ policy. However, if you begin with an ‘occurrence’ form, you should make certain that your initial limits of coverage are adequate to cover any future claims that may arise years from now. You may pay more in premiums, but you have the peace of mind in knowing that you will always be covered against losses occurring during this policy period.
• Choice of Insurers – This is more important that it may first appear. Believe it or not, insurers can and do go out of business for any number of reasons. It is uncommon, but it does happen. If you elect coverage from an insurer with a lower AM-Best financial rating, there is a chance that the insurer may become insolvent and that it may not be around to address any claim that may be filed against your policy in the future – which means that you are uninsured. If you have purchased an ‘occurrence’ form from a lower-rated insurer and that insurer becomes insolvent three years after your policy expires, and then a claim resulting from a latent-defect is made in the fourth year, you have no insurance protection at all.
• Type of Business – Certain businesses or industries must have occurrence policies or have a risk policy in place that guarantees the purchase of prior acts endorsements and tail coverage without fail. Construction businesses (including ‘rehabbing’ and remodeling) where defects may not be discovered for years, are good examples of candidates for this type of coverage. Other businesses have a much lower risk of claims occurring much past the transaction with the customer (such as a mechanic) and can safely choose ‘claims-made’ coverage.
• Availability – Since ‘occurrence’ coverage keeps the insurer ‘on the hook’ for future claims for an indefinite period of time, they are obviously less inclined to offer this type of coverage form, especially for specific high-risk industries like automobile manufacturing where product recalls, costing hundreds of millions of dollars, may occur many years after the policy is out of force and no premiums have been paid. While ‘occurrence’ forms are still available, ‘claims made’ policies are what are normally issued by most insurance carriers these days.
If you have questions, or you would like to speak with someone regarding liability insurance or exposure, please feel free to call our offices at (800) 299-8994 or (512) 986-6124 and we will be happy to answer any questions that you may have.
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. Not knowing these differences could cost you a great deal of money in the event of a loss.
First Things First
To begin with, there is no such thing as ‘full coverage’ insurance for anything, especially real property – period. 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.
What is an ‘Exclusion’
Exclusions are those items specifically outlined in the details of the policy (in the conveniently labeled ‘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’ any additional coverages that you may desire to be protected against.
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 (ie: one ACTUALLY LISTED in 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.
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 versus Dwelling 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 name “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 has NO LIABILITY coverage whatsoever for claims against injury, accident, animal attacks or anything similar and it is only designed to cover buildings and dwellings that are under construction an/or any building supplies that are in, on, or within 100 feet of the premesis. In other words, the contractor himself should have his own builder’s risk policy as a course of business and if you are the one purchasing it, all you are doing is paying to protect the contractor’s tools, trailers, building supplies, and materials against loss – and that’s it. He should send you a ‘Thank You’ car at the end of the job. 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. If you are acting as the contractor (by 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 (in Texas) 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 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 need – including while the property is being renovated. This type of coverage does contain liability coverage to help protect you and it is used mainly for rental properties and NOT for homeowners.
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:
- 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)
- Also contains ‘supplementary payments’ protection at no extra cost (if you chose to accept the liability coverage on the policy)
- Bonds paid with no limit (except up to $250 for bail bonds)
- First aid expenses at the scene of an accident with no limit
- Interest gained on judgments against you (also with no limit)
- A ‘loss of earnings’ feature to pay you up to $200 per day to assist in defending yourself or investigating a claim;
- 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;
- 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, 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.