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.
THE 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.
THE PROBLEMS
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.
THE SOLUTION
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 info@insuranceforinvestors.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
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.
DWELLING POLICIES
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.
To most people, especially investors, an insurance policy is a necessary evil that is assumed to cover just about anything that can cause a loss to a property, but this is simply not true.
To get right to the point, there is no one-size-fits-all policy and properties which are either vacant or held for sale at the time an insurance policy is applied for cannot be written with a standard-market insurance carrier and they require different types of coverages. The following information may seem overwhelming if you are not familiar with the insurance industry, but it is intended to give you a basic understanding of why coverage for vacant property is more expensive and how it differs from the other property policies you may be more familiar with.
A Note About Vacant Property Coverage
First of all, no standard ‘big name’ insurance carriers such as Farmers, Allstate, Safeco, Travelers, State Farm, etc. will issue new policies of any type on properties that are either vacant or actively held for sale at the time of issue unless they are rental properties scheduled to be occupied within the next thirty days. Their underwriting guidelines and ‘appetite’ (an insurance term indicating the risks a company is currently interested in writing business for) specifically prohibit, in very clear and precise language, these types of properties. The reason for this is that vacant properties and those actively held for sale represent a much greater likelihood of loss due to vandalism, theft, arson, unrepaired water leaks, and similar circumstances. From the insurance company’s standpoint, the best way to avoid paying for these losses is to simply not accept the business.
If an agent were to issue a new policy on a property that the carrier prohibits and the carrier learned of it through a property inspection or because of a claim, the agent could lose his appointment and contract with that carrier. In addition, if there was a loss, the carrier would legally deny the claim altogether and cancel the policy ‘flat’ since it should have never been written in the first place per their existing underwriting guidelines and the fact that the property was vacant or for sale was not revealed would be considered ‘material misrepresentation.’ The agent could then face fines and administrative action from the state’s Department of Insurance as well as errors and omissions issues from the customer. In addition, the customer would be left without any coverage for the loss and he or she would have to pay for all all repairs or property replacements out of his or her own pocket.
The Dreaded (and Often Ignored) Vacancy Clause
One caveat to vacant property coverage occures when a previously-occupied and currently insured property becomes vacant, such as when a tenant moves out. All standard-market carriers have a very specific clause, known as the ‘vacancy clause’ written into their dwelling policies which deal with this situation. Each carrier’s clause is a bit different, but they are similar in their intent to reduce the carrier’s exposure to a loss.
In short, if a previously-occupied property becomes vacant for a period of more than 30 days (60 days with some select carriers), the policy either (1) automatically cancels altogether so that there is now no insurance in place or, if the clause is written in such a way as to keep the policy in force, (2) all coverages <water damage, loss of rents, vandalism, etc> are terminated with the exception of coverage for fire and lightening only. Once the property is reoccupied the original coverages are returned.
Where to Get Coverage For Vacant Homes and Property Held For Sale
While standard-market insurance carriers will not issue new business on vacant or for-sale properties, coverage is still readily available – but you will have to pay much more for it and the coverages are greatly reduced.
Policies for these types of properties are written through the ‘Excess and Surplus Lines’ market (referred to as E&S), which many agents know little or nothing about. In addition, agents are required by law to obtain special licensing and education in order to use this market (which fewer than 3% do). Simply stated, this is huge multi-billion dollar insurance market specializing in high-risk, unusual, or hard-to-place risks such as vacant property, commercial property, general liability, and numerous other coverages that the ‘standard’ market does not have an appetite for. This E&S market is comprised of specialty domestic insurers as well as ‘syndicates’ made up of overseas companies, most notably Lloyds of London. How these carriers and syndicates work is another topic for another article, but suffice to say that it’s complicated. Also, because of the nature of their high-risk business, these companies do not advertise directly to consumers and you have probably never heard of any of them, although they are usually extremely financially-stable with hundreds of millions of dollars held in financial reserve.
In order to obtain coverage for a property that is vacant or for sale, you must find an agent that is very knowledgeable with regards to the E&S market and that already has established relationships which enable him or her to write this type business (InsuranceForInvestors has numerous E&S markets available). This is fairly uncommon as the majority of agents have limited industry knowledge and they often focus only on simple home, auto, life, and health insurance.
Also, once you have found someone who understands what it is that you need, you will probably be required to fill out paper applications and the agent will then submit them to the carriers for review.
Most of the policies cannot be quoted online by an agent and, once submitted, it may take anywhere from the same day to several days to get a quote back because the E&S market almost always requires a manual underwriting process because of the unusual and varying nature of the risks that they write – the agent has little or no control over this process. This means that there is very seldom any sort of online rating program or automation which can immediately produce a bindable quote for you.
Unique Characteristics of E&S Policies
As you may have already guessed, there is a very big difference in the actual policies for vacant and for-sale properties than for standard dwelling policies, one of the most notable being the premium. The following list represents some of the major differences that you will need to be aware of.
Premium Amount
The premium for vacant and for-sale properties is always much more expensive than a standard policy because the premium charged reflects the type of risk insured. This premium can be anywhere from 30% to 200% higher depending upon the property, prior loss history, and coverages desired. Also, because of the manner in which E&S carriers are structured, they are usually ‘non-admitted’ to the state in which the property is located, which means that they are required by law to charge state tax and filing/stamping fees. In addition, they may charge policy fees ranging anywhere from $75 to $250 or more (again, depending on the carrier, the risk, and the premium amount).
Minimum Earned Premium (MEP)
All E&S carriers also have a ‘Minimum Earned Premium’, which is normally 25% of the base premium amount not including the taxes and fees. What this means is that at least 25% of the pure base premium is considered to be ‘earned’ by the carrier at the very moment the policy is issued, even if it is only in force for one day. For this reason, all of these policies require at least a 25% non-negotiable down payment at the time of issue. For example, if a policy were issued with a total premium of $ 1,176.50 ($ 1,000 base premium + $ 100 policy fee + $ 76.50 tax), then 25% of the base premium ($ 250) would be considered immediately ‘earned’ and it, along with the fees and tax of $ 176.50 would be due as a down payment in order to start the coverage.
The earned premium, taxes, and all fees are always considered non-refundable.
Premium Financing
E&S carriers are not set up to manage regular monthly billing cycles and they require that the policy premium be paid in full, usually within 15 days of the policy issue.
To prevent having to pay the premium balance in full and to establish a more manageable monthly billing for customers, third-party companies which specialize in the financing of insurance premiums are utilized. Although they work together closely to avoid coverage lapses and billing issues, these specialty finance companies are often unrelated to the carriers themselves and they serve as a third-party intermediary managing premium payments.
Just like when purchasing a care, when the policy is issued, a financing agreement is signed and the down payment (which is paid by the customer and includes taxes and fees) is sent to the carrier issuing the insurance. The remaining balance is then provided by the finance company to the carrier (on behalf of the customer) and the customer then repays the finance company in regular installments. If the customer is late on payment or fails to pay, the finance company notifies the carrier which, in turn, sends a cancellation notice to the customer.
Policy Terms
Many policies for vacant or for-sale properties can be written in either in 6-month or 12-month policy terms, depending upon the carrier. The reason for this is simple; if a property is being sold or is currently vacant, the assumption is that it will either be occupied or sold in the near future so why should a customer have to pay for a 12-month policy if the property might reasonably be occupied or sold within the next 90 days? If you need to extend the term of a policy for any reason, this is easily done.
Differences in the Coverage Provided
There is a tremendous difference in coverages provided between standard dwelling policies and those issued for vacant properties. While the common loss of rents and loss of use coverages are not provided (because the property is not occupied and they are therefore, irrelevant), there are many other differences of which you should be aware.
Vandalism and Malicious Mischief (VM&M) – Because it is the most likely cause of loss, most E&S policies do not include coverage for vandalism and malicious mischief for any reason, though there are some carriers which will offer to include it – for additional premium. If you do have a carrier offering to provide this coverage, you can expect to spend several hundred dollars for it.
Accidental Water Damage – Very few vacant property policies include any coverage whatsoever for damage caused by the accidental discharge of water. While coverage for water damage is often included in dwelling policies for tenant-occupied properties, this coverage is specifically excluded and cannot be endorsed (added) back to pollicies used to insure vacant dwellings. Having said that, there are a few rare cases where some companies may allow you to purchase this coverage for an additional premium, but those additional premiums are often two or three times more than the basic policy premium itself and the coverage becomes cost-prohibitive for most investors.
Theft – Theft coverage is often provided in policies for vacant properties, but you will definitely want to ask the agent to be certain as it is not an absolute guarantee that it is included.
No liability – policies for vacant and for-sale properties often do not include liability coverage to protect you against legal issues and lawsuits arising from injury or other issues arising on or from the property. If you desire liability coverage, you will be required to purchase a separate liability policy or pay much more for a policy which does include liability coverage.
In summary, properly insuring vacant and for-sale properties is a very specialized and unique niche which requires a great deal of knowledge on the part of the agent issuing the policy. The coverages are greatly reduced over those afforded to normal occupied property and it requires that you, the investor, have a good understanding of the risk as well as what coverages you are, and are not, receiving with the policy that you are purchasing.
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.
