Insurance Issues for the Real Estate Investor

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!

As consumers, let alone real estate investors, we tend to flinch when the insurance bill arrives. Many times, for good reason, rates are higher, coverage seems to diminish, and for what? We 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 easier to open.

Most of us consider insurance as a “purchase”. That is, we buy it because we “have to have it”. The attitude that getting the lowest insurance rate makes the most sense has hurt more real estate investors than it has helped. That’s because the agenda for the agent may not fit the needs of the investor. Protecting our assets is more complex than simply finding the cheapest insurance rate.

Inadequate coverage, whether relating to your property or liability, may be just as damaging to your business as no coverage at all. 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 vs. 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. Learn more about these valuation methods here.

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 “grand-fathered”. 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. Learn more about the difference between flood, water damage and sewer backup here.

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.

Basic/Broad/Special (all-risk)

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. Basic and Broad forms put the “burden of proof” on the policyholder in regards to the cause of damage/loss. Special reverses this. Learn more about the differences between these and what to consider when selecting which level of coverage you need here.

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 you may never have heard about. Learn more about AM Best here.

Always work with an Agent you trust, regardless if they are “captive”, or “independent”. Find an Agent that is familiar with our business and willing to take the time to explain the protection you need 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 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 are the people we look to for proper advice and policy structure.

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