You have created an entity to hold title to your real estate, but did you change your insurance policy to reflect the change in ownership?
Unfortunately, some real estate investors who create LLCs, land trusts or other entities to hold title to their real estate forget or improperly update their casualty and liability insurance.
Insurance coverage is a fickle business where seemingly minor incongruities can mean the difference between full coverage, partial coverage or no coverage. When using business entities, listing the entity as the “named insured” is always the best course of action. As the named insured, your entity is protected from liability and casualty claims associated with the real estate.
However, it is not always practical to list your entity as the named insured, especially in the following situations:
• Your carrier will charge a higher fee.
• Your carrier will issue only one policy per entity, and it only covers one property.
• Your property is subject to an existing mortgage, and you do not want to alert your lender to the property transfer for concern it may accelerate your mortgage.
If you fall into one of these situations, then choosing the proper designation for your entity is crucial. When contacting your insurance carrier, be familiar with the following terms:
NAMED INSURED: The “named insured” is the owner of the insurance policy and the only party with the authority to make changes to the policy, file claims, seek modifications, etc. The named insured must always have an insurable interest in the property. An insurable interest exists when a person or entity will obtain some financial benefit from the preservation of the subject matter, or will sustain pecuniary loss from its destruction or impairment when the risk insured against occurs.
ADDITIONAL NAME INSURANCE: An “additional named insured” is similar to the owner of the policy and has all the protections afforded to the named insured.
LOSS PAYEE: A “loss payee” (which automatically includes any mortgagee) is the party who has a secured interest in the property. In the event of a claim or loss, the loss payee will be a party to any payments being released to the named insured.
ADDITIONAL INSURED: An “additional insured” is the insurance term least understood and most misapplied by real estate investors. Additional insureds under an insurance policy receive liability coverage, but not casualty coverage. This approach works well in the majority of situations because the entity is afforded liability protection from claims brought by injured parties. However, there is no coverage whatsoever for physical losses resulting from such things as vandalism, flooding, theft, fire, etc.
This may not be an issue for most investors who name their entity as an additional insured because the investor is the named insured for purposes of casualty loss. However, do not assume this will protect you in all circumstances, for an insurance company could always argue that you, personally, lacked an insurable interest in the property.
ADDITIONAL INTEREST: An “additional interest” offers no coverage and should be avoided. An additional interest is entitled to notification whenever a policy cancels or has a major change made to it—i.e., you find out about changes and nothing else.
With all of the different designations, what is the preferred method for insuring your real estate investments?
The accompanying chart provides a guideline that I use.
Ultimately, insuring your property through an entity comes down to having a discussion with your insurer and/or multiple carriers. Insurance is not a “one size fits all” approach because each state has different requirements for the types of policies a carrier can write.
For example, I recently read one lawyer’s blog wherein he stated real estate investors should name their LLC as an additional insured under their residential policy. This may not work in most instances because a policy insuring an LLC is typically written as a commercial policy.
You may find your carrier refuses to cover your LLC even though the carrier named it as an additional insured. Hence, that is a reason I prefer to use land trusts to hold the title.
Further, land trusts can be the named insured without obtaining a commercial policy, and the change of policy over to a land trust as the named insured does not invite lender scrutiny of legal ownership.