Insurance...Is This Really That Difficult?

As consumers, let alone real estate investors, we tend to flinch whenever the insurance bill arrives. Many times, for good reason: rates are higher, coverages seem to diminish, and for what? We have never even filed a claim! However, if we stop thinking of our insurance policies as just another drain on our cash-flow, and more as a legitimate part of our business plan, that premium notice may be a little bit easier to open...

Most of us consider insurance as a “purchasing endeavor”. That is, we either buy it, or it is sold to us. There, in my opinion, is the foundational fault of the process. The misconception is still prevalent: insurance is mysterious, difficult to understand, and, at best we hope we can trust the person that is selling it to us. We buy it, because we “have to have it”:... As a licensed “agent” in over 40 states, I cringe whenever I hear the word “quote”. Not that getting the best rate for appropriate coverage shouldn't be our goal, but “quoting” in many situations tends to lead to an inadequate transaction between seller (the agent) and end-user (the policyholder) because the agenda for the agent may not fit the needs of the customer (or, as I prefer, client). Please do not misconstrue this as a generalization that all insurance agents are inherently indifferent, or less than legitimate. The attitude that insurance should be treated as a commodity can be blamed on the industry itself, who, as a knee-jerk reaction and effort to grow market share, seem to not really understand the needs of the public. Their Contact us to save $XXX on your Coverage advertising campaigns reinforce the public attitude that insurance is a “one size fits all” industry and getting the lowest rate makes the most sense. Unfortunately, when you really need it, this planning, or lack thereof, has hurt more consumers than it has ever helped.

Too many of us, when building our real estate investing portfolios, consider our insurance program as an afterthought. Those of us who do understand some of its value, may not fully comprehend its place in our business plan/model. I consistently receive calls and emails from people who ask if I think an LLC, an S-Corporation, a Land Trust, or any other entity created to buy/own real estate is the best option over another for them. These bevy of inquiries bolster my theory that the right advice is still not promulgated in our industries (insurance AND real estate investing) to a sufficient and/or acceptable degree. Contrary to popular opinion, insurance should not be the foundation of an asset protection strategy. Think of your assets, whether personal or business, as the items within your castle that you desire to protect. The legal entities that you create, with the advice and assi stance of a legal professional, are the castle walls, the moat, and the watchtower you build to help protect them. What you choose to create is a summation of the needs and issues in which tax, financial, and even estate planning must be taken into consideration. Acknowledge that insurance is the archer in the watch tower, or the knights with the boiling oil, that attempt to keep nasty things like liability claims, fire, windstorms and other catastrophes at bay. We all know insurance does not cover everything. The list of exclusions in most policies is more than a paragraph. Likewise, the archer does not hit every target. That stated, the archer and knights (insurance) need to work in conjunction the walls and the moats legal entities) to appropriately protect your “stuff”. Protecting your assets is more complex than simply finding the cheapest insurance rate.

“That is a nice explanation, and worth consideration, but how does that help me when my next premium comes due”, you may be thinking... Inadequate coverage, whether relating to your property or liability, may be just as damaging to your business model as no coverage at all. There are many cost-saving mechanisms that you can employ, far short of short-changing coverage. These are but a few:

Higher deductibles---Take a glance at the deductible you have on all your insurance policies. Chances are, if you increase each of them to the next higher incremental level, the premium savings generated will more than offset the difference. A solid rule-of-thumb is to take the minimum claim you would file, double it, and use that as your preferred deductible on any policy. If you would never file a $1000 claim, then certainly don't carry a $500 deductible. Besides, as real estate investors, we typically don't pay “retail” for supplies or labor when it comes to construction / rehab / repair...A deductible is, by definition, “self-insurance”. I am an advocate of self-insuring that which you can control or is of a known amount (a deductible, or even the vacant property you got at a tax sale for $10,000). However, self-insuring unknown risk, such as liability, even with an asset protection strategy in place, is rarely a good idea.

Combining coverages---The more opportunity you have to combine coverages on either the same policy, or with the same carrier, usually the better rate you get. If you have 6 rental properties on 6 different policies, not only are you potentially paying a higher rate due to internal policy fees, etc... on each, you may end up paying far more than you think in the event of a catastrophe, such as a wind or hailstorm. On separate policies, you have separate deductibles...If multiple locations are damaged, your deductible will apply per location. On a master, or “blanket”-type policy, where all properties are combined, the deductible usually applies per occurrence. Knowing this, and choosing a deductible that is appropriate for your business, goes a long way in helping you when you really need it...In the recent windstorms as a result of Hurricane Ike, I had one client that had over 150 properties damaged. She had a $5000 deductible. Thank goodness she only had to deal with it once, because her properties were combined on one policy. Otherwise, her 10 years of building a large portfolio of properties may have been wasted...

Dropping coverages you do not need---A quick review of a policy will usually indicate how much you are paying for unnecessary coverages. As real estate investors, many of us have been financially blessed, even in the current economic turmoil. With multiple vehicles at home, do we really need to pay for the “rental car coverage”? If our vehicles are newer, many times “Roadside Assistance” is built in to our purchase or lease. If you are still paying for “Towing” coverage on your auto insurance policy, it's probably a waste of a few dollars. I realize that many of these items are “nickels and dimes”. However, they are yours, and you should spend them on things that you need. Consider re-allocating these premium dollars into higher liability limits, for instance.

Find an insurance “Advisor” that understands what it is you need/desire to protect. Let them work with appropriate advice from all of your business team members (attorney, CPA, and financial planner) to develop a fluid adaptable model that makes sense for you. As part of your business plan, insurance can help you when you need it, but not drain you when you do not. Understanding some of the basics of how insurance affects you business is a great start in ensuring you have what you need (when you need it)!

A working knowledge of insurance should be a requisite requirement in high school curriculum. Unfortunately, it isn’t. If one of your single-families caught fire last night, are you certain it is insured properly? If a spring storm blew the roof off of your 12-unit apartment building, would you have coverage for your loss-of-rents? Is your subject-to exposure protected? When it comes to insuring your investment properties, it is best to know what protection you have, or don’t have, before a claim. It is always nice to save a few dollars to add to your net income, but make sure you are aware, and more importantly, comfortable with your coverage levels and options.

ACV v s. Replacement Cost:

Make sure that you understand the difference between the two options. Also understand what a coinsurance penalty is, and how it may apply to your units. Every property, and property owner, for that matter, is different. Your comfort with how these options affect your coverage is vital for you to make an educated decision on which option to carry per property. ACV may be “cheaper”, but could cost you when depreciation is applied to a claim.

Liability Limits:

Always carry as much liability protection as you can afford. As a minimum, you should carry $1,000,000 per occurrence. The larger your portfolio, the more liability protection you should have. Surprisingly, there is a minimal premium charge in most cases to double your protection. An umbrella policy is a method to provide liability coverage beyond the standard $1,000,000 or $2,000,000 limits. An umbrella is usually more cost effective when you have more than one type of liability exposure.

Other Structures and Personal Property Coverages:

Don’t forget to protect against loss of detached structures, such as garages, sheds, and outbuildings. Some policies automatically include limits for these. Also remember to protect items in the units such as refrigerators, stoves, and window air conditioning units. Again, some policies may automatically provide built-in protection for these items.

Ordinance and Law Coverage:

This provides protection for additional costs you may occur in order to bring your damaged property “back to code”, as it is repaired from a loss. As time passes and building code changes, most properties are “grandfathered”. However, the repairs that are inspected by the governing municipality are required to be to current code. Hard-wired smoke detectors and handicapped accessibility are two such examples. Without the Ordinance and Law endorsement, such work is typically not covered under your policy. Older properties and multi-unit properties are more at risk for this situation.

Loss-of-rents, or Business Income Coverage:

This provides coverage for your lack of rental income, if your tenants are forced out of your property due to a covered loss. Some policies have built-in coverage to a certain time limit, such as 12 months. Other policies may have an endorsement you must purchase at specific levels of coverage. Either way, this is protection all property owners should have.

Deductibles:

Simply stated, the higher your deductible, the lower your premium. If you are a multi-property owner, and your units are insured under separate policies, your deductible will apply, per location, if you are on what is typically referred to as a “package” or “blanket” policy, your deductible usually applies per occurrence. This could be a big difference, out-of-pocket, in the event of a local catastrophe such as a tornado.

Earthquake, Water Backup and Flood Coverage:

Most policies have exclusions for such losses. You can buy these coverages back through endorsements. Make sure you understand how each coverage may apply, respective of your chosen insurance carrier. This will ensure you can make an educated decision on whether you should have any or all of these coverages.

Insuring the Proper Entity:

Make sure you protect YOUR (or your entity’s) interests. It is not worth sacrificing the proper protection to avoid the dreaded “due-on-sale” clause. The entity that owns the property should be the first-named insured. The first-named insured is the primary recipient of policy benefits. Additional insured and loss-payee endorsements may suffice in certain situations. However, as a general rule always aim to be the first-named on the insurance contract.

Using the “Best” Insurance Company:

The insurance company (or companies) you use should be one with the financial strength to deliver on their contractual obligation when a claim occurs. AM Best and other company rating services are good places to “investigate” insurance carriers. That stated, some of the best companies available are ones of which you may never have heard. As such, always work with an Agent you can trust, regardless if they are “captive”, or “independent”. An Agent that is familiar with our business and willing to take the time and explain your protection needs for your situation, even if they can’t offer the policy themselves. We all like to save money, but you purchase insurance for protection. Make sure you understand how it works, before you need it. Basic insurance terminology and issues apply to many types of businesses s and scenarios. A deductible is a deductible, for instance. However, in the world of real estate investing, some of the creativity that is required to make a deal happen, can throw many insurance people and companies into a spin. Lease-options, land contracts, and other acquisition strategies are common for us as real estate professionals, but not so common the people we look to for proper advice and policy structure. One of the most incorrectly addressed situations is the property that is purchase “subject to” the existing financing/mortgage.

It is a commonly misunderstood challenge: clarifying the timeless issue of how to properly insure a “subject to” property. The obvious dilemma is the “Due on Sale” (DOS) clause being invoked and the mortgage company calling the note. Though seemingly complex, some common sense rules-of-thumb usually apply. If you (or your entity) own, or have a financial “stake” in the property, be the “first named insured”. The first named insured is the primary recipient of any potential claim benefit or liability protection. An “additional insured” will garner liability protection only. A “loss payee” will have its interests protected in the event the property itself is damaged. (A mortgagee is inherently BOTH). If you decide to keep the “homeowner’s” policy in place and be named as the additional insured, be advised. If it is discovered that the ex-owner, the firstnamed insured in this case, no longer owns the property, expect the insurer to deny based upon the fact the policyholder no longer owns the property. Even if you manage the claim to be paid, you are not the entity to receive the proceeds, as you are not the first-named insured. If you did attempt to be added as a loss payee as well, chances are the insurer will question the necessity for you being named as such. When the insurer discovers you now own the property, they will need to write a new policy.

The proper way to insure the property, once you (or your entity) owns it, is to have a non-owner occupied “landlord” policy, with you as the new first named insured. The bank/mortgage company is named, as normal, as mortgagee. The prior owner should be named as the additional insured ONLY. Naming the prior owner as additional insured will usually keep the mortgage company happy. But, you may ask, why not keep the ex-owners policy in place? One concern of carrying 2 policies on the same property is that most policies have “excess” clauses. In other words, the policy will pay only excess amounts, if any other policy exists. If each of the 2 policies have such a clause it will create havoc in getting a loss paid...

To further clarify the scenario here is a hypothetical example: Property has a “homeowner” and a “landlord” policy (both) on it. Fire occurs. Owner files a claim under the landlord policy. So far, so good. However, “tenant” (prior owner, or new occupant), has personal property damage. He must also file claim, but against his “homeowners” or tenants policy. The respective insurance company on each claim is bound to find out of the other policy’s existence and could (more than likely would) attempt to invoke the “excess” clause of it’s own contract, potentially leaving the owner waiting for courts/arbitration to settle... I wouldn’t take the chance with 2 policies. If an insurer has an opportunity to mitigate, or deny, a loss if there are contractual issue s, be sure they’ll try! (As an added note, if the prior owner moves out, the “homeowners” policy is no longer valid as the property is now “non-owner-occupied”). Bottom line: if you own it, you insure it. If the fact that a DOS clause is/would be invoked if the insurance policy changes, I would walk away before potentially diminishing or even sacrificing coverage by trying to “skirt” the correct way to insure the property. In 12 years, we have yet to have a loan called (knock wood) by insuring the new owner on a “landlord” policy and naming the bank (and the old owner) as mortgagee and additional insured respectively.

Another common misconception is the issue of “personal” versus “commercial” insurance, especially pertaining to real estate investments. Though there are exceptions, usually the utilization of a commercial policy trumps that of a “dwelling fire” (personal) one. Many times, the reason this advice is ignored by my insurance industry peers is either they: 1. Do not have the knowledge, or; 2. Do not have the carrier (company) contracts or relationships. If either is the case, do not ever let an agent dictate the proper utilization of insurance in your business, unless they understand why commercial insurance is the most appropriate coverage methodology.

Reasons A Commercial Policy Is Better:

Many commercial forms will include coverages such as rental loss and additions and alterations Coverage.

To increase liability on a commercial form from the typical $300,000 to even $2,000,000 is minimal (around $50 per year for the entire contract---regardless of number of units) with most carriers

The generic pollution exclusion found on most personal type contracts is addressed by some commercial policies to consider/cover pollution that emanates from a heating source (i.e. carbon monoxide).

On a master (AKA “blanket”) policy, as you grow and add properties, the rate drops proportionately.

Personal policies only insure one property per policy.

Related to #4, in the event of a catastrophe, such as a tornado, the deductible applies once for the occurrence, not per location.

The deviations to carry higher deductibles are cost-effective under a commercial policy much more so than most personal contracts. In other words, carrying a $2500 deductible on the commercial policy may save 15% of premium versus a $1000 deductible. On a personal policy, the same change my only generate half the savings…gives some food for thought on consideration of catastrophic deductibles such as a $5000 or more especially as you add more units.

Many insurers limit the number of units they will insure under personal contracts, and as you’ve discovered, will not consider non-personally owned properties for coverage. I don’t like the idea of the insurance company limiting my asset protection options in this manner.

The “fire and hazard” policy you have may be a named-peril policy only. The commercial policy can and should be written on an “all-risk” form. “All-risk” simply means that unless a peril is excluded, it is covered.

With many commercial policies, you have the ability to add newly acquired properties up to $250,000 automatically for 90 days. You many times have up to 90 days to call and add the location to the policy.

Insurance is the one thing for which we pay that we never want to use. However, in the event you need it, you certainly want to be properly protected. The points presented here should hopefully allow you to grasp a few of the pertinent insurance issues for whatever your real estate endeavor may be.

The sufficiency of personal insurance for your investment properties is one of many myths that are pervasive in the insurance/real estate investing industries. Many others that are commonly misconceived, are presented in no particular order:

1. Insurance is mutually exclusive of estate, tax, and financial planning…

 Actually, insurance inter-relates to each of these, as they should work in harmony with one another. You attorney, accountant, financial planner, AND insurance advisor should certainly know what each of the other has planned specific to your goals. As such, excluding one from the others is contradictory to efficiency and cost-effectiveness. Consider these four folks a s your “trusted team of advisors” and encourage them to consult one another as necessary. 

2. Being named as an “additional insured” on the existing homeowner policy will protect my interests in a subject-to deal…

 This could do much more harm than good, in reality, if you (or your entity) own, or have a financial “stake” in the property, be the “first named insured”. The first named insured is the primary recipient of any potential claim benefit or liability protection. An “additional insured” will garner liability protection only. A “loss payee” will have its interests protected in the event the property itself is damaged. (A mortgagee is inherently BOTH). If you decide to keep the “homeowner’s” policy in place and be named as the additional insured, be advised. If it is discovered that the ex-owner, the first-named insured in this case, no longer owns the property, expect the insurer to deny based upon the fact the policyholder no longer owns the property. Even if you manage the claim to be paid, you are not the entity to receive the proceeds, as you are not the first-named insured. If you did attempt to be added as a loss payee as well, chances are the insurer will question the necessity for you being named as such. When the insurer discovers you now own the property, they will need to write a new policy.

3. Buying a property in your personal name and using your homeowner’s policy liability is fine…

 I can’t think of any reason that exposing your personal assets to the risk of real estate investing makes sense. If this is the only option your current insurance person suggested, then either find one that is more real estate investing-savvy, or take the time to help them understand more about what you do. The last I want to do is tie-in “my stuff” to the exposures of my real estate investments. Asset protection strategization inherently is a combination of insurance, entity creation, and “compartmentalization”.

 4. The “personal” dwelling fire policy is sufficient (“cheap”) to cover my non-owner occupied rental…

 Those that usually promulgate this attitude in the insurance industry either don’t have commercial-type carriers/markets and/or proper knowledge. Not only does the dwelling fire policy require liability to be extended from your homeowner’s policy (see #3), many coverages that are vital to a true “rental” property are either missing or need to be purchased over and above. Though the basis of a completely different presentation, some of the highlights of the "commercial policy preference” are the inclusion of rental loss coverage, unit limitations, and pollution exclusion issues.

5. I have a personal umbrella policy (PUL), so I don’t need commercial insurance…

 Like most insurance polices, your personal umbrella protection contains much exclusion. One of the most glaring for the real estate investor is the “business pursuit” exclusion. If your real estate investment(s) aren’t a “business pursuit”, then you need to consider divesting! In other words, your PUL is designed for “personal” exposures. A commercial umbrella over and above the liability in your commercial package policy is appropriate.  

6. A claim that occurred before I (or my entity) owned the property shouldn’t affect MY insurance rate…

 The insurance industry not only underwrites “you”, they also underwrite and rate based upon the claims history of the property itself. A CLUE (Comprehensive Loss Underwriting Exchange) report will detail the claims that have occurred at a certain address (as well as other criteria). Have your insurance advisor run a CLUE on your next property BEFORE you make an offer. The insurance rate can certainly affect your ROI…

 7. “All-risk” insurance covers everything I need…

 By definition, “all-risk” simply means that unless something is excluded, it is covered. “Named peril,” means just that, in order for a loss to be covered, its cause must be named in the policy. So, even though “all-risk” is a more comprehensive form, it does not mean that “everything” is covered. Take a look at your policy exclusions. Not that many of these exclusions can’t be purchased back, but they usually generate a pretty long list.

 8. Self-insurance is too risky…

 A deductible is technically self-insurance. As a rule-of-thumb, consider the lowest claim amount you would file with the insurance carrier, then double it. This is the minimum deductible I would suggest you carry. There is a point of diminishing return, however. In other words, though you may not file a $5,000 claim, if the premium savings it (versus, for instance, a $2500 deductible) is negligible, then you may as well go with the lower. In the long run, statistically, the premium savings by carrying “higher than usual” deductibles usually pay for themselves. Remember also, that completely self-insuring a known amount, such as a property with an arguable repair or reconstruction value, can be a consideration. However, self insuring unknown amounts, such as liability claims, may not be the best idea.

 9. I need “builder’s risk” coverage for a vacant or rehab project/deal/property…

Unless the rehab is “considerable” (definition varies by insurer), there are policies specifically designed for the rehab property. In our area, Diamond States, AMIG (American Modern), and Foremost all offer such contracts. If an insurance agent advises that they cannot find coverage for your rehab property and offers the Ohio Fair Plan, chances are they simply don’t have they contracts with the carriers mentioned. The Ohio Fair Plan should be the last option for the property, not the first.

10. It is worth it to hire the “handyman” to do work on my rentals…

 Don’t get caught up in the great bid to do work in/on your rental property or rehab project from the “fly-by night” handyman-type help. Chances are, they not only do not carry liability insurance (puts the risk back on you as the owner), they also probably don’t carry worker’s compensation (WC) protection. It isn’t worth the risk to save a few bucks to not hire the “legitimate” contractor for such endeavors. Even the tenant who cuts the grass for reduced rent potentially exposes you to WC and liability issues. Always require contractors to provide certificates of insurance (COIs) for both their liability and WC coverages.

 (Bonus) Cheaper is better…

 The cliché rings true: you get that for which you pay. Work with an insurance advisor that understands the idiosyncrasies of real estate investing. They can be an independent or a “captive” agent. As long as they have a recognition of the challenges that face your investing endeavors, and have access to a carrier (or carriers) that fill your needs (in conjunction with the strategies discussed here), challenge them to get you the best VALUE for your insurance, not the cheapest rate.

 Insurance is a gamble. The insurer is betting you won’t need it, while you bet that you will. With the help of a professional insurance advisor, gain enough knowledge to make cognizant decisions on your specific needs. As part of an asset protection plan, it is vital that you are comfortable with your coverage and protection BEFORE you need it. I sincerely hope all of your premium dollars go to waste!

 www.nreinsurance.com

 “The right coverage at the right time"

 National Real Estate Insurance Group, LLC 888-741-8454

 Affinity Group Management, Inc 800-790-4872

One response to “Insurance...Is This Really That Difficult?

  1. Nonrenewing a homeowners insurance policy is a decision you or your insurance company can make to discontinue coverage at the end of a policy term. Depending on your state, if your insurance company chooses to nonrenew your policy at the end of the policy term, it must notify you and provide an explanation within a specified time period. You can contact your company's consumer affairs division if you disagree with the reason or want further explanation.

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