Insurance expert discusses policies for multiunit communities

Editor's note: Today, Barbara Holland has given over her column to Mark S. Coolman, of Western Risk Insurance, to discuss property insurance for condominium, townhome, cooperative communities.

Does your insurance agent really know what an homeowners association needs? Is that agent qualified to interpret the association's documents?

To answer that question we must review the association's covenants, conditions and restrictions, Nevada Revised Statutes 116 and Federal Mortgage Regulations.

Common law and NRS places the responsibility on the insured person to determine if the coverage is proper and adequate for the risks. Buyer beware is the age-old maxim here.

Associations need many types of insurance. In this article I will deal with only property insurance for multiunit buildings such as condominiums, townhomes and cooperatives.

Buildings can be insured using one of three property forms.

ALL-INCLUSIVE INSURANCE POLICY

The most comprehensive is called all-inclusive. That form covers anything that is part of the building at the time of loss, including owner-installed upgrades, regardless of their cost.

Most associations do not obtain this kind of policy. The main drawback to this coverage is an owner may have remodeled his unit at a cost of $500 per square foot; and there is no way of knowing that, until there is a loss.

SINGLE ENTITY INSURANCE POLICY

The majority of multiunit building policies are issued using the Single entity. That form provides coverage to rebuild the unit to its original specifications, both inside and outside.

In this case, the unit owner's personal insurance would be responsible to cover the cost of any improvements and upgrades to the home.

BARE WALLS INSURANCE POLICY

The final form is bare walls. This rebuilds just the structural components, exterior shell and walls only to the initial interior surface. It does not replace any interior walls, fixtures, cabinets, flooring or doors.

HOW TO DECIDE WHAT POLICY YOU NEED

I am seeing an alarming trend as certain agents and insurance companies are replacing single-entity coverage with bare walls. Fifty percent of all condominium owners do not have a personal insurance policy.

So now if there is a major loss and the outside is rebuilt what we end up with is what I like to call a black hole in one of the buildings.

I think the main purpose of an association is to preserve property values. If there is an uninhabitable unit in one of the buildings that reduces the value of all the units.

Why are these policies offered? The answer would be: to save costs on property insurance. That short-sighted approach could very well backfire and cost the association a huge amount of money.

Each state has laws that regulate planned unit development. Each association has its own set of CC&Rs, bylaws and resolutions. There are federal regulations that require certain insurance policies if the mortgage are through Federal Housing Administration, Veterans Affairs, Fannie Mae or Freddie Mac.

NRS 116.3113 gives us the minimum requirements and basically states that property insurance must be at least 80 percent of its actual cash value, and must include the units, but need not include improvements and upgrades installed by the unit owner. So the key here is what is the definition of unit? NRS 116.2105 states the community's CC&Rs define the units.

BARE WALLS POLICY NOT ENOUGH

I just reviewed the CC&Rs for an HOA that has a bare walls policy in place. The definition of unit clearly states that the interior space is part of that unit, including fixtures and equipment. The insurance section of the community's governing documents states all units must be insured to 100 percent of replacement cost, including all fixtures and equipment.

In this association a unit owner would have a reasonable expectation that the association followed the governing documents and NRS 116. If that owner suffers a property loss and there is no coverage, I think the liability issue will be 10 times greater than the property issue.

I am involved in just such a case right now where the unit owner is a litigation attorney for an insurance company. A six-figure settlement is being offered.

If there are more that 20 units, there must be fidelity coverage in place for the maximum amount of funds that will be in the custody of the association or management company at any time.

The CC&Rs for the association, which I've presented as an example, had in its insurance section a paragraph that stated the master policy will issue certificates that meet all the requirements of federal mortgage programs.

Again, the bare walls format does not do that. The overwhelming majority of governing documents do not define a unit as only the exterior shell of the buildings and require mortgage certificates that meet lenders requirements to be issued.

So, why do these agents tell you bare walls form is proper coverage? Why do some HOA boards want bare walls coverage?

There are a few reasons. Most HOAs will quote the maintenance section of the documents. The documents usually place the maintenance responsibilities on the unit owners. The maintenance section has nothing to do with the insurance requirements, these are separate issues.

What the section does is relieve the association of the responsibility to repair the interiors because of wear and tear and noninsured damage. The maintenance section does not remove, change or delete the insurance section or NRS 116.3113 requirements.

The second most quoted reason is that the damage is the fault of the unit owner. Property insurance has nothing to do with fault. It is pure contractual transfer of risk designed to protect the value of collateral for the lenders.

The third reason is the agent feels he or she can make a sale only by saving the association money. Many associations are looking for any possible way to save funds during this economic down turn. It may be the only product the agent's insurance company offers. Who does the agent represent?

OWNERS SHOULD HAVE PERSONAL POLICIES

FHA and Fannie Mae have issued new regulations as to the minimum requirements for master polices. Most of those requirements were in place but not followed. The regulations places additional requirements on the unit owner.

The property coverage must be for 100 percent replacement cost of the inside and outside of the unit. If the master policy is bare walls, then the unit owner must purchase a walls-in HO6 in the amount of at least 20 percent of the appraised value.

I contend that in Nevada 95 percent of all condominium associations must use the single entity form of property insurance when all the documents and laws are reviewed.

A good rule of thumb is that the buildings should be insured as they were delivered. If the original owner received a unit with a built-out interior, then insure the entire unit

If he or she purchased only space and built his or her own interior (many high-rises do that) then bare walls could be used if, and only if, the documents allow.

Barbara Holland, certified property manager, broker and supervisory certified association manager, is president and owner of H&L Realty and Management Co. Questions may be sent to Association Q&A, P.O. Box 7440, Las Vegas, NV 89125. Fax is 385-3759, email is support@hlrealty.com.