Multifamily Insurance Trips and Traps
By Keat Foong, Executive Editor
Surely every property owner’s nightmares must include finding out in the aftermath of a hurricane, fire or a lawsuit that insurance does not cover the costs. What a disaster! Apartment owners must be very careful to risk-manage properly and make sure their assets have the correct insurance policies.
Experts’ advice for ensuring proper insurance protection for apartment properties typically fall into three categories: Making sure that the right type of insurance is purchased, ensuring that enough coverage is purchased and selecting the right insurance broker.
Simply opting for the policy with the lowest premium “just because they are trying to save money” is one of the most common pitfalls of apartment owners, says Carlton Einsel, executive vice president of The Donaldson Group, a third-party apartment manager. “But people do that,” he adds.
According to attorney Barry Fleishman, partner at Kilpatrick Townsend & Stockton LLP, the most typical missteps apartment companies can make include not adequately understanding the coverage, not reviewing the actual policy terms with their brokers and legal counsel, and failing to compare losses in the past to their current coverage. Insurance is a very difficult and complex field, says Fleishman, and the risk manager or CFO should work closely with the broker and/or an insurance attorney to make sure there are no unintended gaps in the protection.
What type of insurance to purchase
First, apartment owners need to ensure the correct type of insurance is acquired. Experts advise that owners purchase all-risk—rather than named-peril—insurance, whether the insurance is third-party property insurance or general liability insurance. This is because named-peril insurance covers only risks that are specifically named, whereas all-risk insurance covers all risks except those explicitly excluded. Property owners should also be careful to have policies that reimburse at replacement cost—and that cover business interruption.
“Buy broad, all-risk, policies, rather than named-peril policies,” says Steve Cataldo, director of risk management at Greystar, which oversees insurance for a management portfolio of more than 48,000 apartment units.
Property insurance coverage generally applies to “all risks,” such as fire, explosions, earthquakes, tornados and hurricanes, with the exception of specific exclusions. Fleishman, a legal specialist in policyholder insurance coverage, says it’s important that the apartment company review the risk history of the property and the areas in which losses were suffered in the past, and then ensure that none of these exposures are excluded from coverage.
The terms of the insurance, naturally, will be influenced by the location of the property. If the apartment asset is close to a disaster prone area, such as a flood or an earthquake zone, the insurance policy will likely contain sublimits that may be much lower than the coverage for the basic perils.
Certain perils such as windstorms and earthquakes may also carry higher deductibles, depending on the location of the asset, adds Derek Ramsey, Greystar CFO. The apartment owner needs to determine its ability to fund the deductible if a loss occurs. If available cash will be insufficient to meet that deductible, then the owner may want to consider paying a higher premium in order to obtain a lower deductible, he points out.
If coverage for particular risks-—such as flood, pollution or earthquakes in certain regions—is not found in traditional types of policies, the property owner may be able to look to alternative instruments for managing risks. These alternative instruments, which can be very sophisticated, include specialty risk policies (such as pollution liability policies), catastrophe bonds, self-insurance supported by re-insurance, or industry risk retention pools, says Fleishman.
As regards both liability and property insurance, Fleishman advises that apartment owners ensure that all layers of insurance—primary, umbrella and excess—be consistent with each other. For example, property owners should make sure that certain excluded losses in primary layers are not also excluded in umbrella or excess layers. In such cases, there would be a gap in coverage.
“Sit with your broker (or attorney) and go through the policy page by page(it takes one day or so), and understand what is in the policy: what is covered and what is excluded,” he says. “The broker should make sure the policy is consistent in each layer of insurance or tell the client where it is not.”
The hazards of replacement
Property owners should also be careful to obtain insurance that will reimburse them for the replacement, rather than acquisition, cost of the assets. Inadequate limits of insurance can present a problem even if the property owner believes he or she is obtaining full replacement-cost insurance coverage, notes Greystar’s Cataldo. Cataldo says that property insurance carriers commonly issue full replacement-cost insurance, but impose separate sublimits on certain perils, including floods, windstorms and earthquakes.
Even if there are no sublimits on the replacement cost proceeds, Cataldo advises property owners to try to insure their properties at the full replacement cost. It is very important that the owner knows accurately what the cost to replace the asset is, and what the insurance limit is on the property. One reason is that if the property owner insures the property for materially less than the full replacement cost of the property—whether to save money on premiums or for other reasons—and the full replacement cost turns out to be greater than the insured amount, the policy holder may only be entitled to collect the lower amount from the insurance company, notes Cataldo.
Furthermore, in many cases in which there is a material loss, the mortgage lender is entitled to receive the insurance proceeds and may not be required to advance them to the owner to repair or rebuild the asset if there is a difference between the cost to replace and the insurance proceeds, Cataldo explains.
Other than insuring for replacement costs, apartment owners must also remember to establish business interruption insurance, not just first-party property damage insurance. According to Fleishman, business interruption insurance is normally included in the property insurance policy. However, the property owner should understand limits and restrictions on the insurance, he says. There may be time restrictions, for example. Apartment companies need to really understand business interruption insurance, says Fleishman. “You need to go over the terms with your broker.”
The other broad category of insurance is general liability insurance, which covers claims brought against the policy holder for third-party property damage or bodily injury. Overseers of apartments need to make sure the liability insurance they acquire does not exclude certain activities currently taking place on the property, such as methamphetamine-producing laboratories. “If the activity happens to be one, then the policy will exclude damage from that type of property,” says Cataldo.
Under liability insurance, most defense costs do not fall under the insurance limits, says Fleishman. However, it is important to understand that for certain policies, such as directors’ and officers’ policies, defense costs are subject to the insurance limits, and can “eat up” the insurance, Fleishman says. That is why the determination of how much coverage to purchase needs to be fully reviewed by purchasers.
Finding the right middle-man
Selecting the correct broker is also a part of getting the right insurance coverage. In this regard, The Donaldson Group’s Einsel says that it is easiest for brokers to go to market with
the information supplied by the client, but
most difficult to find brokers who can obtain the best policies and who have the best process to handle claims.
“If you have a claim, you do not want to waste weeks and months arguing [with the broker],” says Einsel, who advises that the owner should select brokers they know would handle claims quickly.
Sources interviewed all agree that property owners need to ask their brokers whether they have any existing relationships with carriers. Cataldo says risk retention groups do establish pools of sponsored programs, and the insurance broker may participate in the underwriting profits and incomes or obtain a commission. He notes that such arrangements are acceptable to the apartment company, but they need to be disclosed. Einsel agrees. “If you do not know,” he explains, “you could end up buying the policies when you are really being steered to that carrier because the broker is getting fees out of it.”
Finally, another important consideration for the apartment owner when purchasing insurance is the ability and/or willingness of the insurance company to pay claims when there is an expensive disaster, such as an earthquake in California, Cataldo points out. Not all insurance companies are created equal. And for apartment owners that do not have mortgages on their properties and therefore lender guidance on buying insurance, it is important to remember to check on the Standard & Poor’s or A.M. Best ratings of the insurance company.
“Ask the insurance agent or broker who
places the insurance what the insurance company’s rating is before the coverage is placed,” Cataldo advises.
As Einsel says, “Very often, we do not go with the lowest cost provider. If the insurance carrier is not as strong, we may decide on a higher-priced carrier.” For example, The Donaldson Group has a lot of policies with Travellers, even though it can obtain lower-cost policies with other companies. But, Einsel adds, Travellers is a very solid company with a long history.