As the end of the year approaches, many associations around the country are dealing with the renewal of their insurance policies. Especially in coastal states, these policies can often amount to a quarter or more of the annual budget, so of course this is a tremendously contentious issue for board members. How much insurance is appropriate, and is any amount ever too much?
The vast majority of state statutes, not to mention almost every SOC document, provides that the association must insure the common elements for some large amount, anywhere from 75% to 80% of replacement value, all the way to full replacement value. Of course, the question of “full value” depends on an independent appraisal, and some of these may not be so independent. Is a higher number always better?
An insurance broker recently approached our association with a sure-fire way to save money on insurance. In Florida, every association is required to insure the property against hazards for “the replacement cost of the property to be insured.” Ordinarily, this means that the association gets a full appraisal of the property, and then purchases both hazard and windstorm (hurricane) insurance for that full amount. His argument, however, is that the damage that can be expected in a windstorm is far lower than other hazards (such as a fire, which could potentially destroy the building). So when this agent solicits appraisals from his “independent” appraiser, he asks for three different numbers–replacement cost for windstorm, flood, and then all other hazards. The windstorm appraisal is typically only a quarter of the total value of the property (using the theory that a windstorm is unlikely to damage the actual foundation of the property or make it uninhabitable), thereby saving many thousands of dollars in insurance premiums.
Certainly an attractive proposal to boards who are constantly pressured by owners to save money! However, it is my opinion that this strategy is extremely risky, and here’s why. This type of appraisal system, assuming that it is even legal (and it does clearly require some interpretation of the statute), requires a leap of faith that a windstorm event would NEVER result in a complete loss. If it ever did, the association would, in fact, be uninsured for that loss. The broker’s opinion was that, in fact, a windstorm could never result in a total loss of the property.
However, based on prior storms, this philosophy is simply not accurate. In fact, prior to Hurricane Andrew it was common to insure properties against windstorm damage for far less than other hazards, using exactly the above argument. However, anyone who was in South Florida for Andrew knows that many properties suffered a total loss, and not always in ways that were predicable. In one large condominium, the pressure created by the storm created a back flow in the water system that caused the pipes at the top of the building to burst, raining down a flood of water into the building that destroyed the property completely. There is absolutely no reason to assume that modern buildings, simply because they are built using post-Andrew construction standards, could NEVER suffer a complete loss in the case of a windstorm. So any board that would elect to use the above reasoning to secure insurance that is below full replacement value is taking a tremendous gamble. Further, many policies will not even pay out on an appraisal that is later found to have been incomplete or undervalued (even if the damage claimed is within policy limits.
So how does this story apply nationally? Every region of the country has different hazards that must be insured against, and the costs will vary significantly. Owners and board members should be careful that their passion for savings doesn’t overwhelm common sense and good business practices, because spending even thousands of dollars per unit each year in insurance is a drop in the bucket compared to the devastation of a total loss event. So make your insurance choices carefully!