This one chapter excerpt of the original presentation will help debunk a common myth about policies and coverage options that are avaible for real estate investors. It will provide truths regarding coverages you need to best protect your investment properties. Whether you are just getting started or a seasoned investor, DEBUNKING the 13 Insurance Myths for the Real Estate Investor chapter 7 will give you the knowledge and confidence to know your assets are protected and your business is secure.
Please keep in mind, NREIG is willing to provide you with a full policy/coverage comparison of what you currently carry and what NREIG can provide.
As each myth is covered, keep in mind they are just that, myths. These are the most common misconceptions we have come across in dealing with hundreds of new clients across the country. In most cases, we are able to speak to clients prior to a loss which could have put their business in jeopardy. But in other cases, clients come to us after a loss which could have been prevented if proper coverage had been in place.
ALL POLICIES AND COVERAGES ARE CREATED EQUALLY
I always like to start off with the Basic, Broad and Special coverage forms as these are the three industry-wide property coverage forms available to you as an investor. Before you choose which coverage form is best for you, please make sure you take into consideration more than just the cost of the policy options. There can be up to a 30% difference between these policy forms and it is up to you as the investor to determine if the additional exclusions associated with the cheaper coverage forms is really worth the risk for you.
Basic vs. Special Form Coverages
NREIG offers either a Basic or Special coverage form option. Broad form is not offered nearly as often, but we will cover it as well. As you can probably guess, Special form is the most comrehensive and in turn, the most expensive coverage form you can purchase. It is considered “All-Risk” coverage, meaning that unless there are specific exclusions listed within the policy, then coverage is afforded to you in the event a loss . The burden of proof falls on the insurance company to prove that the peril that caused the loss is specifically excluded. There are six standard exclusions that come on every Special form policy (some of which can be purchased as an endorsement or stand-alone policy and others cannot), these are:
- Mold & Fungus
- Wear & Tear
- Sewer & Drain Back-Up
- Intentional Tenant Damage
In addition, if your location falls in a tier 1 or 2 county (meaning a county that touches coastal waters or one county removed), Named Windstorm or Hurricane coverage, may also be excluded. Be sure to review your exclusions and endorsements pages to make sure no other exclusions have been “slipped in” your policy. One common coverage exclusion that is added is theft.
Basic form is the second coverage form most carriers (including NREIG) offers to investors. Basic form coverage can save you approximately 25% – 30% per year (depending on the carrier), but comes with some additional exclusions to ones listed above, that you will need to consider. They are as follows:
- Falling Objects
- Theft (keep in mind, this is for things you own such as the air conditioning unit and the copper pipes in the wall, not your tenants belongings)
- Weight of Ice, Sleet or Snow
- Water Damage (which is most commonly known as coverage for frozen and burst pipes).
In the event of a loss, the burden of proof falls on you to prove the loss was caused by an included peril.
Broad form is the in-between form not often used. Reason being is the cost savings provided is not enough to make sense to purchase. It is basically Special form minus theft coverage. It typically saves you 10% from a Special form policy. For the additional 10%, it is a better option to simply purchase Special form.
Things to consider when deciding on a Special or Basic form policy:
- Is my property in an area where Weight of Ice, Sleet or Snow and Water Damage is high risk to me? If not, then Basic form might be a better option.
- If my location is a flip, will the property still be in my possession when the temperatures get cold? If not, then Basic form might be a better option.
- Is theft coverage a concern? If the location is occupied, then that threat should be diminished. As you can probably imagine, theft most often occurs at vacant locations. If the location is a flip or undergoing renovation, will there be enough owned materials and appliances at the location to make sense carrying theft coverage? Keeping in mind that your general contractor’s tools and materials are NOT covered under your policy. We will discuss this later.
Actual Cash Value vs. Replacement Cost
The next piece for you to consider is whether you want to be insured on Actual Cash Value (ACV) or Replacement Cost (RC). If you are not familiar with the difference between the two, let’s go over them. Actual Cash Value is typically 20%-25% cheaper than a Replacement Cost policy, allows you to be insured to a lower value per square foot but does figure depreciation into the settlement of your claim. Replacement Cost requires you to be insured to a higher valuation per square foot but provides you with the opportunity to recover all depreciation that was initially levied against you. Let’s run through a claims example (all companies settle claims the same way) and then touch on some things to consider when deciding between RC and ACV.
You suffer a partial loss at your property, a kitchen fire that causes $30,000 of damage. The assigned claims adjuster will visit the property and determine how much useful life was left in what was damaged (to figure in the depreciation of the loss). For a nice, round number let’s say they depreciate the loss at 40% meaning 12,000 will be depreciated from the $30,000 loss. Leaving you with a payout of $18,000.
**As a side note, depreciation is extremely difficult to determine until the loss occurs. It is taken off of the date of the last updates, not the original year built. Everything depreciates at a different rate, but the average is about 1% per year. Other than the roof that deteriorates much quicker due to the exposure to the weather**
Then they take your deductible out of the settlement, let’s say it is $3,000. This leaves you with an Actual Cash Value settlement of $15,000 to cover your $30,000 fire loss.
If you are on an ACV policy, this is all you can recover (and by the way, that money is yours to do with what you want – sell the property with the damage existing and use the money to go on vacation, buy a car, you get the point). If you are on Replacement Cost, you can go back to the carrier and recoup some or all of the depreciation that was taken from you. The way you do this is to first exhaust the initial ACV payment of $15,000 on repairs, make the remaining repairs out of pocket, submit the receipts to your insurance carrier and they will reimburse you for up to $12,000. The only part that is not recoverable to you on an RC policy is your deductible.
Things to consider when deciding on an ACV or RC policy:
- I always recommend that you consider what your plan would be in the event of a total loss. Would you rebuild the property or would you clean the land up, sell it and move on to another property? If you would not rebuild the property, then there is little reason as to why you would pay for Replacement Cost coverage because you are paying more to the insurance company than you will ever recover in the event of a loss. Remember, you have to actually make the repairs at the property to be able to recover your depreciation.
- The reason I say concern yourself with what your plan would be in the event of a total loss and not so much a partial loss is for a couple of reasons:
- You most likely can make the repairs (or have access to someone who can) for substantially less than what your insurance carrier thinks you can.
- 60%-65% of the investors insured with us that suffer a partial loss and are on Replacement Cost, never come back and recoup any depreciation. Not because they don’t want to, but because the ACV settlement was more than enough to make them whole again.
- If you have a loan on the property, most likely your lender is going to have a set of insurance lending requirements you will have to meet or exceed. Often times, they require Replacement Cost coverage.
Coinsurance is the last piece we will address. Coinsurance is an industry-wide property provision that states the amount of coverage that must be maintained as a percentage of the total value of the property at the time of loss. The penalty is based on a percentage stated within the policy and the amount reported. Common coinsurance are 80, 90 or 100% (the higher the percentage is, the worse it is for you) of the value of the insured property. It is important to note, here at NREIG we have no coinsurance provided you are insured to $50 per square foot or higher. Let’s discuss an example of how a coinsurance penalty could be assessed in the event a loss occurs and you are deemed to be underinsured.
Let’s refer back to the partial kitchen fore we covered earlier. The claims adjuster will also determine that if the location had been a total loss, how much the property would cost to rebuild. For an even number, let’s say they determine it would cost $100,000 to rebuild. Then they refer to the declarations pages of your policy and see you have an 80% coinsurance clause on your policy. Meaning you agree, when entering into this agreement with your carrier, to be insured to 80% of the true replacement cost of the policy just determined to be $100,000. Provided you are carrying $80,000 or more of building coverage, you have met your coinsurance clause. However, if you are insured to $79,999 or less you will be assessed a coinsurance penalty based on the percentage you are underinsured. This is done prior to figuring in the depreciation and the deductible (so they can take the percentage off of the larger amount).
Now if you are looking at your declarations pages and scratching your head as to why you are insuring your 1,000 square foot home for $150,000, then you need to look no further than your coinsurance clause. Many carriers (in an attempt to avoid a coinsurance penalty being assessed to you in the event of a loss), greatly inflate the ITV (Insurance to Value) of the property. The last thing your agent wants is you in their office upset after a loss occurs because in addition to being hit with depreciation, you also are being hit with a coinsurance penalty. So the better alternative is to charge you a higher premium for more coverage than you will ever recover in the event of a loss.
NREIG works with you to determine what valuation per square foot you want to be insured to. We provide you with Actual Cash Value coverage and NO Coinsurance beginning at $50 per square foot. Replacement Cost with NO Coinsurance begins at $70 per square foot.
About the Author
Shawn is the Senior Vice President of REIGuard and National Real Estate Insurance Group. He is an industry-recognized speaker and educator with an emphasis on Commercial Property and Premises Liability. Over the last nine years, he has studied extensively on these lines of coverage to bring to you DEBUNKING the 13 Insurance Myths for the Real Estate Investor.
Note: This piece is no t to be constructed as contractual. Applicable policy language supersedes it specific to your policy supersedes it. Information contained in this excerpt is intended to provide you with a brief overview of the coverages provided for reference purposes only. It is not intended to provide you with all policy exclusions, limitations and conditions.