EDITOR’S NOTE: This excerpt from “Debunking the 13 Insurance Myths for the Real Estate Investor” explores insurance exclusivity, named additional insured on your homeowner’s policy and using your homeowner’s policy to cover your investment properties. Whether you are just getting started or are a seasoned investor, our aim is to educate and give you the confidence that your assets are protected and your business is secure.
These are the most common misconceptions we have come across in dealing with hundreds of new insurance clients across the country. In most cases, we are able to speak to clients prior to a loss that could have put their business in jeopardy. But in other cases, clients come to us after a loss that could have been prevented if proper coverage had been in place.
One quick note before we delve into the subject matter: You will see commercial insurance policies referenced as the coverage you should have. In the insurance world, commercial insurance policies are best utilized to cover anything from single-family dwellings to large apartment complexes and all lines of commercial real estate in-between.
Myth #1: INSURANCE IS EXCLUSIVE OF ESTATE, TAX AND FINANCIAL PLANNING
One of the first questions we are frequently asked is, “Should I form an LLC to protect my properties or is insuring in my personal name sufficient?” Unfortunately, the answer varies from investor to investor.
What you do with your investment properties depends upon many factors, including estate planning, tax planning, financial planning, etc. We advise our clients to build a trusted team of advisers that includes attorneys, accountants, property managers, insurance agents and/or your estate planning attorney. Use your team of trusted advisers to come up with the best plan of action to protect your investments. Regular communication with your team is vital, and heeding their opinions could save you thousands of dollars.
Why is this important? Let’s say you are a new investor purchasing your first property. You buy it in your personal name. The loan and all necessary closing documents, including your insurance policy, are also in your name. You receive your certificates of insurance and insurance policy listing you as the first named insured. Six months later, you acquire a few additional properties and then decide it’s best to form an LLC for your locations, including the original property in your personal name. A few weeks later, the tenant in your first property trips and falls down the steps. The tenant files suit against your LLC. The first document the tenant’s attorney asks for is your insurance policy to see your included limits of liability. Upon receiving the attorney’s letter informing you of the lawsuit on your LLC for the tenant’s injuries, pain and suffering, you turn the letter in to your policy carrier. Your liability carrier notifies you the claim is being denied because you do not have a policy with your LLC as the first named insured. This is an example of why you want to keep your insurance agent in the loop.
Use your team of advisers as your castle walls and moat. They’re there to protect your business and provide you with the solid foundation needed for your business to succeed. Think of your insurance agent as your “archer in the watchtower.” Your agent is doing his or her best to keep things from damaging your property. Insurance agents may not catch everything, but they are doing the best they can to stop what they can.
Myth #2: BEING NAMED AS AN ADDITIONAL INSURED ON AN EXISITNG HOMEOWNERS POLICY WILL SUFFICIENTLY PROTECT YOUR INTERESTS IN A SUBJECT-TO DEAL
A “subject-to” deal is when you agree to purchase a property subject to the existing mortgage along with all other liens attached. The existing homeowner deeds the property to you, and you take over making the payments to the lending institution. You do not assume the loan through the bank.
Then why is being named as an “additional insured” on an existing homeowner’s policy not sufficient coverage? In the event you do go through a claim at one of your locations, the claim’s settlement checks paid to repair the property are made out to the first “named insured” AND all “additional insured.” Let’s say you are only listed as an “additional insured” on the homeowners’ policy, and a fire damages the property. In that case, the previous homeowner has the same rights to the claim’s check as you. We have witnessed instances with a previous company where the insurance carrier made a mistake and only listed the first “named insured” on the claim settlement check, failing to list the lender. In this instance, the owner of the property made $1.2 million on the claim settlement and left the country, leaving the lender with only a burned-out apartment building.
Now let’s discuss the correct way to insure your property in a “subject-to” deal. If you have ownership and financial interest in the property, you better be first “named insured” on the insurance policy. The lender is going to receive notice from the carrier when the homeowner’s policy is canceled. If the lender is doing its job, that means hounding the homeowner for proof of replacement coverage. This is where the policy you purchased will suffice. When reviewing the evidence of insurance you provide, the lender will make sure:
1. The business entity is listed as first “named insured.”
2. The mortgagee clause is listed correctly to protect its interest in the property.
3. The building value provided by your carrier meets or exceeds the amount of the loan to satisfy the lender’s interest in the location.
4. Most importantly, the homeowner must be listed somewhere on the certificates.
REIGuard lists the owner on the documents, but on the liability certificate only. Owners are included on the liability only because on a liability loss the settlement checks are made out to the injured party, not the “named insured” or any “additional insured” parties. In the event of a liability loss occurring at the property with the homeowner named in the lawsuit, your liability policy coverage will extend to them.
Myth #3: BUYING A PROPERTY IN YOUR PERSONAL NAME AND USING YOUR HOMEOWNERS LIABILITY POLICY IS FINE
This is a common mistake for many new investors when closing on their first investment property. Many will contact their local agent who insures their home and auto policies and request to add the investment property coverage. The easiest thing for your agent to do is to add your investment property to your homeowner’s liability policy. Even though this is a quick and inexpensive way to proceed, it can be detrimental to you and your business.
Personal lines liability policies may be a cheaper way to get coverage in place, but they contain coverage “gaps,” leaving you severely exposed. One major example is “Pollution” coverage. Personal lines liability policies all contain a “Total Pollution Exclusion,” which on your liability policy is coverage for carbon monoxide. Personal lines liability policy does not include this coverage because there is no recourse against your homeowners policy if the home you live in has a carbon monoxide leak and you or a family member fall ill. Your investment property, however, is an entirely different story.
Let’s say you have a tenant living in your investment property who gets sick or, even worse, passes away from what is determined to be carbon monoxide poisoning. Say this property is insured on your personal lines liability policy, which contains the “Total Pollution Exclusion.” You would be defending this claim on your own, and as you can imagine, it can get quite expensive.
Commercial lines policy will surpass the coverages provided to you on your homeowner’s policy. These policies are often more expensive than personal lines polices, but do not jeopardize your coverage and your business to save a few bucks.
REIGuard recommends you treat your investment properties like the businesses they are. As previously mentioned, combining personal and commercial lines policies can harm your investments. Assume you have your investment properties included on your personal lines liability policy, and your policy has a common $300,000 per occurrence limit. Using the example above, you have a tenant who passes away due to carbon monoxide poisoning at your investment property. The wrongful death lawsuit could easily exceed the single $300,000 limit of coverage. If it does, because your liability policy collectively insures everything you own, both personal and business, the injured party could go after your personal and business assets. If you have your liability policies structured properly and a large loss occurs, you are typically only exposed up to the amount of coverage your liability policy provides per occurrence.
Never purchase a commercial lines liability policy with a limit lower than $1,000,000 per occurrence. These insurance lines often come with a $2,000,000 aggregate limit for the annual policy term. One single occurrence transpiring at your investment property in which you are deemed negligent will deplete the $300,000 limit rather quickly. If the defense costs your liability carrier “inside” of your policy limit—meaning they are deducted from your per-occurrence limit—it will further decrease the amount you have. Always ask your agent to provide you with a liability policy where defense costs are “outside” of your coverage limits.