EDITOR’S NOTE: This excerpt is a continuation from “Debunking the 13 Insurance Myths for the Real Estate Investor,” which we began last issue. We’re exploring three common misperceptions about personal dwellings’ fire policy sufficiency for nonowner rentals, umbrella policies and how claims prior to owning a property can affect your insurance rates. This article will provide truths regarding coverages you need to best protect your investment properties. Whether you are just getting started or are a seasoned investor, our aim is to give you the knowledge and confidence to know your assets are protected and your business is secure.
These are some of the most common misconceptions about insurance that we have come across in dealing with hundreds of new clients across the country. In most cases, we are able to speak to clients before a loss that could have put their business in jeopardy. Unfortunately, some investors aren’t so lucky.
One quick note before we delve into the subject matter: You will see commercial insurance policies referenced as what 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.
A PERSONAL DWELLING FIRE POLICY IS SUFFICIENT TO COVER MY NON-OWNER-OCCUPIED RENTAL
We had the opportunity to work with a newer investor who recently converted the home he had owned and occupied for years into an investment property. He now has a tenant who has been living in the home for more than a year. Our first question to him was, “Did you let your insurance agent know you were converting this location into an investment property?” He quickly answered, “No.” He didn’t feel the need to. After our conversation, we asked him to contact his agent to ask whether the policy in force was one that extended coverage to a property being occupied by a tenant, a “non-owner” property. His agent replied that the company would need to cancel his existing policy and rewrite a new policy to insure this new exposure.
What would have happened if a fire had occurred in the prior year while he had been renting out the home? The assigned claims adjuster would have visited the property to investigate the loss. During this visit, the adjuster would have discovered the home was not “owner occupied.” The policy purchased was for an “owner-occupied dwelling.” Therefore, the insurance carrier would have declined the claim due to material misrepresentation. The owner would have been left on his own to rebuild his investment property.
Don’t give the insurance carrier a reason to deny a claim. If you are reviewing your declaration pages on your current policy and are unsure if you have the correct type of policy to cover your non-owner-occupied dwelling, email your agent and ask for clarification. We always recommend you use email so you have the response in writing. If something happens in the future, you will have leverage in the event of a declined claim, if needed.
I HAVE A PERSONAL UMBRELLA POLICY SO I DON’T NEED ‘COMMERCIAL’ INSURANCE
We hear this myth on daily basis. Insurance agents collectively do a poor job of explaining to their clients what an umbrella policy is and isn’t. An umbrella policy is not a “magic bullet” that covers everything. In fact, it extends zero coverage to your structure—or any property coverage at all! Umbrella policies are a way to garner additional liability coverage above and beyond what your underlying or primary liability policy provides to you. Meaning, if your underlying liability policy provides you with $1 million per occurrence and you purchase a $5 million umbrella, you have increased the per-occurrence limit of coverage to $6 million.
Similar to the liability policies we discussed earlier, personal-line umbrella policies are underwritten very differently from commercial-line umbrella policies. Many personal-line umbrella policies contain a “Total Business Venture Exclusion.” Even if you pay to include your investment properties on your personal-line umbrella policy, it’s possible you have no additional coverage through your umbrella because of this exclusion.
Umbrella polices also do not provide you with “first dollar” coverage. Your underlying liability policy limits would have to be exhausted in order for your umbrella policy to provide coverage. In addition, do not purchase a liability policy that could have exclusions. Common exclusions that can do more harm than good are pollution and coverage for dog bites. Your umbrella policy will not save you if coverage is excluded on your underlying liability policy. Your umbrella policy almost always “follows” your underlying liability policy, meaning if something is excluded on your underlying liability policy, your umbrella policy excludes it as well. In more than nine years, we have only seen one umbrella carrier willing to drop down and provide first-dollar coverage for a limited number of excluded coverages on the underlying liability policy. The kickers to this are:
These options are much more expensive, and you are better off just purchasing a more comprehensive underlying policy.
These also come with a $10,000—at minimum—self-insured retention for any loss excluded by the underlying liability policy being picked up by the umbrella policy.
Last point on the umbrella policies: Your underlying liability and umbrella policies need to be the same type of policy in order for them to work together. A commercial umbrella policy will not go over a personal-line liability policy, and vice versa.
A CLAIM THAT OCCURRED BEFORE I OWNED THE PROPERTY SHOULDN’T AFFECT MY INSURANCE RATE
How great would this be? Not having to pay for the “sins” of the past owner. Well, believe it or not, up until about five years ago, this was the case. Anyone could purchase a new investment property without having to research or provide any details regarding past insurance claims to the new insurance company. Unfortunately, for everyone, insurance carriers are all becoming like Big Brother and are sharing information. It is now on you, as the potential buyer, to complete your due diligence and provide accurate loss information to your insurer for the past three to five years, depending on the specific carrier requirements.
Let’s Take a Look
So, you are picking up your first investment property, and you call your agent, get a quote and bind coverage prior to closing. You think you are all squared away, until 30 days down the road, you receive a notice from your insurance carrier stating either:
- Your policy is being canceled because previous loss history was not disclosed to them.
- They will agree to keep you, but your annual premium is increasing from $500 to $1,500 due to the increased exposure.
- The point of the example is this: Do your due diligence before purchasing any property so you know exactly what you are purchasing.
How do we go about obtaining prior insurance loss history on a location I am considering purchasing?
If you are buying the property from the current homeowner, you will need to obtain a C.L.U.E. (Comprehensive Loss Underwriting Exchange) report. You can purchase one of these reports from LexisNexis, a data collection company, for $10 to $12 per report. This report will provide you with the prior insurance claims filed at the property, the type of claim and approximate total payout.
If you are purchasing the property from another investor, and the property is already being used as an investment property, you need to ask the seller to obtain a Loss Run report from the insurance carrier on risk. The seller will have to get this report from his insurance agent or current insurance carrier. This typically takes two to four days. The report shows the same loss information as a C.L.U.E. report does. It also will give you a great idea of the property’s history and what you can expect moving forward.
Things to look for on C.L.U.E. and Loss Run reports are:
- Both frequency and severity of losses are looked at the same by most carriers. Several nickel-and-dime-type losses or one catastrophic loss could both be looked at as high risk.
- Controllable losses are looked at very differently from “Acts of God.” Fires, specifically tenant-caused fires, theft and water damage are viewed more negatively than a wind or hail loss or even a lightning strike.
- Look carefully at locations that have suffered flood losses. These locations are prone to suffering those types of losses again. And once a flood occurs and a claim is paid, it is both difficult and expensive to obtain this coverage on future properties. It also makes it much more difficult to sell the property in the future if there is a history of flood losses.
If liability losses are present, look at the cause of loss and see if the same tenant who caused the claim is still living at the property.
These are just a few of the items you need to strongly consider when reviewing the loss history at a location in question. If you are still sold on purchasing a location that has some negative loss history and you are experiencing difficulties with purchasing affordable insurance coverage, consider requesting a higher deductible for your entire policy or at least for the perils that have been loss issues for the past owner. For example, if frozen and burst pipes have been an issue in the past, request a higher deductible for that specific peril. If the past loss had a payout of $8,000, then request a $10,000 deductible for that peril, if financially it makes sense for you. This will offset the risk and “cover up” the loss altogether. Do not jeopardize your business by taking on a higher deductible than what you can stomach as an owner. You are better off looking for another property to purchase or paying the higher insurance premium.