Insurance is a vital component for any business. And having the proper insurance coverage can make a big difference when a loss occurs. We have Scott Kroening with us today to share why investors shouldn’t insure their properties under their Homeowners policies and what they should consider instead.
Scott spent the first seven years of his career as a Probation Officer. He realized he was never going to be happy in law enforcement. So, he set off to find a new career where he could still help people and that’s when he found insurance. His first role was as a Catastrophe Claims Representative with Farmers Insurance. There, over a course of 24 years, Scott worked his way up through many different roles and promotions. Last year, Scott decided to join the NREIG team and now serves as the NREIG Program Managing Director. Scott and his wife invest in renovation properties, doing most of the cosmetic work themselves. Welcome to Insured Investors!
Why do people insure their properties under homeowners policies?
I would say there’s a few reasons. It’s not common knowledge for most people to understand how an insurance policy reads. If you’re a newer investor, haven’t spoken with your agent, or you’re not familiar with your policy and what the coverages or limits are, incorrect assumptions are made. The problem is you don’t have clarity around which direction you could go, or you may not even know that there’s a difference. So just flat lack of experience is the thing that I would point out first.
Second, from a human path of least resistance perspective, it’s quicker and easier. Most people, if they do have knowledge of their homeowners policy, just do what’s easier and what they’re familiar with.
And then the next thing is cost. Most of us are very cost-conscious. We want to save as much money as possible, and I get that, but if you’re paying for something that will potentially not be covered, what’s the point of paying for it at all?
Is it a bad idea to insure investment properties under a traditional homeowners policy?
You have to kind of ask yourself, “What are the policies designed to do or designed to cover?” So, on the homeowners side, you’re thinking through things like your personal, owner-occupied property. On the commercial side, it’s a little different. You’re thinking through tenants and the property.
Liability differences between an owner-occupied and tenant-occupied home can be huge. That renter probably doesn’t care quite as much about their rental home as they would about their own home, which can lead to a lot more liability issues. Carriers know that and that leads to a different cost, because additional risk equals additional premium. It comes down to just being aware of the differences between an owner-occupied and tenant-occupied home. And if you don’t know that, naturally, you have got to reach out to the people who do.
There are a couple of other things too, like coverages, in general, are going to be different. There are limit gaps as well. You want to make sure that whatever you’re getting on your policy is enough coverage and that those specific a la carte items you may want, like Flood or Earth Movement, are included. Being insured incorrectly or inadequately could lead to claim denials.
Tell us more about the coverage gaps that investors are exposed to when insuring investments under homeowner policies.
We could have a whole entire additional podcast on just this topic, but there are a couple key points that come to mind. For example, limit gaps. On the homeowner side, the liability limit is typically $300k or $500k. And again, with the additional risks with investment properties, you need more than that. I personally would never advise a client to have those limits that low. Commercial liability policies typically have higher limits. At NREIG, we start at $1m per occurrence and you can go from there. It’s worth it because liability claims can get pricey. You must think about the costs of defending yourself on the legal side, costs can increase quickly.
The other thing that comes to my mind is how exclusions differ between policies. One specific blanket exclusion on the homeowners side is the total pollution exclusion. It literally excludes anything carbon monoxide related, meaning you would be left defending the claim on your own. Now in our policies that we provide, it is a Commercial policy, which means we could afford coverage for that. It’s not just flat excluded.
How could claims be impacted if you are covered under the wrong policy?
You’re most likely not going to be paid on a claim if your property is insured incorrectly. Generally, you want to keep your personal and business assets separate. If you are sued, you don’t want to have those assets tied together because they could go after everything – personal and business.
How you structure a policy is important too. How you’d like a Named Insured on your personal house is going to be your name, maybe your spouse’s name too. With investment properties, investors oftentimes own the property under an LLC. In that case, your Named Insured needs to be your LLC, not your personal name. If it’s not it could lead to delays or even non-payments. Commercial policies are better structured for businesses in that way because you can keep those expenses separate.
What should you do if you plan to turn your current residence into a rental?
First and foremost, be educated on what this change means for you. Contact your insurance agents and let them know. They may need to change the status. If you don’t, there’s a thing called material misrepresentation. It’s a form of fraud. And a lot of people don’t even realize when they’re making this mistake. I’m actually one of them and I’ll tell you about it here in a second.
Let’s say you insure your rental property on a homeowners policy, there’s a fire that takes place and your adjuster comes out and realizes that your tenant caused the fire and damages. The adjuster sees that your property is under a homeowners policy and that isn’t right. The carrier would likely deny the claim due to material misrepresentation because you were paying the premium based on the risk associated with an owner-occupied dwelling which was not correct. You want to avoid that at all costs.
I’ll give you an example and throw myself under the bus here. Back in probably 2005, I built a house, brand new, from the ground up. Fast forward a couple of years, boom, 2008 happens and the market tanks. I’m in a personal situation where I really need to get out of this house, and I can’t sell it. It’s on the market for a while and I conclude I’m going to have to rent this out because I don’t want to short sell it, right? So, I found a renter and for some reason, I just never called my insurance agent. I’m in the industry. I should have known these things, but I didn’t, so how should investors who aren’t in insurance know any better? It probably happens a lot and it’s scary, you know?
So, let’s say I own a home and I decided to start renting it out. The first thing I should probably do is contact my agent, tell them specifically what I’m using the property for, and start looking at a commercial policy versus my homeowner policy. There are a lot of different property statuses, every property has a different risk and therefore a different premium. If it’s not correct and there is a loss, it could lead to a claims denial.
What about the investors that own vacation rentals and reside in them part-time?
It’s similar to what we just discussed. It’s potentially a status change and needs to be shared with your insurance agent. Vacation rentals have additional liability needs. So, the first step is to be honest and open with your agent and ask them how to structure this policy. There are many ways to do it, but as long as you’re starting there, getting advice from an expert, and moving forward in that direction, it’s the best way to go.
Sometimes homeowners policies flat exclude short-term rentals altogether. So, keep that in mind.
Outside of being covered correctly, are there any additional benefits to insuring your property under a commercial policy?
Yeah, for sure. One thing that jumps to mind is Loss of Use and Loss of Rent. I’ll give an example. You own a home, and you are living in it. Let’s say the kitchen burns down and your house is deemed unlivable. Under a traditional homeowners policy, Loss of Use would come into play and help pay for living expenses while the kitchen is being repaired. Conversely, if this was a rental property and the same thing happened, you, the investor, would lose rental income. Commercial policies provide Loss of Rent coverage, which can help investors recoup some of that income.
There are some other things too, like vacant properties. The risks with vacant properties are high. It’s harder to maintain heat and avoid burst pipes in cold snaps. And if there is a leak, it may take a long time before it’s noticed, which means more damage. Things like that increase the risk and carriers know this. You must be cognizant of those things and how your policy covers them.
Lastly, many homeowners policies won’t even let you add more than five investment properties. Commercial policies aren’t as limited. At NREIG, we do almost as much as you want. Hundreds, if that’s how you want to do it and you want it in one place.
— Game Segment: Fact or Fiction —
We are going to play a game, Fact or Fiction. So, we’ll share some landlord “statistics” from Flex and you are going to tell us if you think they are true or not.
Fact or fiction? The average landlord has three properties.
Fact.
Fact or fiction? “Mom and Pop” landlords own 10 million rental units in the U.S.
Fiction. They own 20.5 million, which is approximately 41% of all rental units.
Fact or fiction? 10.6 million Americans earn income from rental properties.
Fact
Fact or fiction? 30% of properties experience some form of vacancy every year.
Fiction. It’s actually 41%.
Fact or Fiction? Half of single-property landlords purchased the property as a primary residence first.
Fact.
Watch the full interview here!
