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Adapting the HO-6 To Cover Higher Association Deductibles

WITH the large number of weather-related property claims in the past five years and with the dollar amount of claims far exceeding premiums, the pricing of habitational property insurance has skyrocketed; in some cases, the coverage has become unavailable. This development has adversely affected the finances of condominium and townhouse associations, which traditionally have insured the ownership interest of all unit owners under a single master policy. In the past two or three years, nearly all the major players-insurers who in the past have aggressively competed for these master policies have fled the scene. Only a handful today are open to new association business--and then only for very preferred risks (built in the last 20 years, no more than one or two claims in three years, roof recently replaced, no swimming pools, etc.). Often, coverage for associations with an unfavorable loss history must be sought in the surplus-lines market, where rates can be 300% to 800% higher.

Here are three examples of this problem that I've witnessed first-hand as a consultant. Each association had filed three to five claims in the preceding three years, most of them water-damage claims (broken pipes) for less than $5,000 each. One 100-unit association, which had paid $13,000 a year until it was nonrenewed, could not find replacement coverage for less than $72,000. For a 40-unit association, which had been paying $8,000 a year, the best price available for replacement insurance was $56,000 a year. The insurance cost for a 250-unit association went from $35,000 a year to $280,000. Each association had a half-dozen agents scouring every known admitted insurance company and was willing to accept deductibles as high as $25,000. Not one taker!

When faced with overwhelming cost increases, most associations, even loss-free ones, do the prudent thing-they raise their property insurance deductibles. The usual $1,000 deductible becomes $5,000, $10,000, or even $25,000. Not only do the higher deductibles reduce today's premium, but they also eliminate most of the small losses. Fewer losses reduce future premiums and protect the policy from nonrenewal.

But here's the $64,000 question: If a master policy now has a $25,000 deductible, whose responsibility is it? The norm is for the unit owner or owners affected by a particular loss to pay for the master policy deductible. The association pays the deductible and assesses all members only when a loss affects all units; e.g., in event of a storm. (As we'll discuss a little later, however, associations' legal documents often aren't clear on this point.)

If you are the agent for a unit owner whose 40-unit association has just raised the master policy's deductible to $25,000, how can you insure that $25,000 exposure under your client's HO-6 policy? Which coverage does a unit owner need to purchase to cover that higher deductible? Does the unit owner need more building coverage (Coverage A) or more loss assessment coverage (found under Additional Coverages)? To answer that question, consider two claim scenarios: a $50,000 claim for a kitchen fire wholly contained to just your client's unit and a $300,000 hail-storm claim for replacing all the roofs in the association. In the first claim, your client would be responsible for the entire $25,000 deductible. The only way to cover that risk is by increasing Coverage A by $25,000. If you sold your client $25,000 of increased loss assessment coverage thinking that it would cover the deductible, you'd be wrong.The HO-6 insurer normally would either deny coverage completely (loss assessment coverage covers only association-wide assessments) or would pay only $1,000. (Most endorsements for increased loss assessments usually contain a $1,000 cap for assessment of association deductibles.)

What your client needs, then, is $25,000 of additional building coverage. Here's how the two claims should be adjusted for a 40-unit association with a $25,000 master policy deductible if your client has $25,000 of additional Coverage A insurance:

  • In the $50,000 fire, HO-6 Coverage A should pay the entire $25,000 master policy deductible.

  • In the $300,000 hailstorm, your unit owner's HO-6 loss assessment coverage would pay the $625 assessment for your client's share of the deductible ($25,000 divided by 40 units).

Protecting clients from claim disputes

Some insurance company claims departments balk at paying for the master policy deductible under Coverage A. The reason? Their HO-6 policy is excess over the master policy. They argue that an excess policy isn't required to pay the deductible of the primary policy.

I personally disagree with that interpretation, as does Michael Arnold, CPCU, of Harleysville Insurance Co., who is the most knowledgeable property claims adjuster I have ever met in my 33 years in this business.

As Mike puts it: "The HO-6 insuring agreement clearly insures real property available for the exclusive use of the insured. The Other Insurance provision of the HO-6 (4-91) states, 'If a loss covered by this policy is also covered by other insurance, except insurance in the name of a corporation or association of property owners, we pay only the proportion of the loss that the limit of liability that applies under this policy bears to the total amount of insurance covering the loss. If, at the time of loss, there is other insurance in the name of the corporation or association of property owners covering the same property covered by this policy, this insurance will be excess over the amount recoverable under such insurance.'

"As the deductible amount is not recoverable under the association policy, and the loss is to property that is included in the definition as covered property, the HO insurer should pay those excess amounts."

Although Mike didn't add it, this assumes, of course, that the HO-6 Coverage A limit is adequate to cover the amount of damage and that the cause of loss is covered. The standard HO-6 building perils are named perils--not special perils. Water damage from a bad roof leak is only covered by Special Perils--one more reason why it's imperative that agents always change Coverage A to Special Perils. Another good reason is that by broadening perils covered, you automatically broaden loss assessment covered perils from named-only to special, as well.

Here's how you can save your clients (and yourself) a lot of headaches at claim time:

  • Survey the claims managers of all your HO-6 markets now. Send them a copy of this article. Request in writing or via e-mail their companies' position on covering a master policy deductible under Coverage A of their HO-6 policies. Save their responses. (By getting the response in writing, you protect your client should a new claim manager with a different philosophy come on board.)

  • For any insurer whose claims manager disagrees that the company's HO-6's Coverage A applies to a master policy's deductible, stop using it as an HO-6 market in your agency for clients with more than a $1,000 master policy deductible responsibility.

  • Last, but definitely not least, read the agreements of your client's association. Make sure they are clear about who pays the association building deductible. If they aren't, point out that oversight to the association's board of directors. An HO-6 insurer will pay a master policy deductible under Coverage A only if the association's legal documents explicitly make the individual unit owner responsible for it. It won't pay the deductible just because your client is getting billed for it.

  • I have read at least 100 association agreements. Most failed to even mention the master policy deductible, let alone spell out who is responsible for it at claim time. The dilemma I see is that association boards, facing staggering price increases for insurance, are opting to raise the master policy deductible without amending their bylaws/declaration documents to say who is responsible for the deductible. (Not only a mess at claim time but also a potential D&O claim against the remiss board members.)

Every association board that raises its master policy deductible should also amend the insurance section of the declaration document to specify under what circumstances the deductible will be charged against an individual unit owner or owners affected by a loss and under what circumstances the deductible will be assessed against all unit owners.

Truly, the HO-6 policy is one of the most difficult personal-lines policies to arrange correctly (see sidebar on page 82), but doing so will pay big dividends for your clients.

Ten steps to a well-designed HO-6 insurance policy

1) Request a copy of the association's "declaration" document. Make a list of building items not covered by the association's master policy (e.g., carpets, hardwood floors, tile floors, kitchen cabinets, plumbing and electrical fixtures serving the individual unit, built-in appliances, unit owner improvements.)

2) Have your client estimate the replacement cost of all structural items that are his or her responsibility. (The easiest and most accurate way to do this is to write a list of all such items and then have the client estimate the replacement cost of each.)

3) Ascertain the current master policy deductible as well as the maximum deductible authorized in the declaration. Choose the higher.

4) Add up the totals in Steps 2 and 3. Round up to allow for errors. That total should be the coverage limit for Coverage A.

5) Add "special perils" coverage to Coverage A, changing the perils covered from "named perils" to "all risks" unless excluded. This is important for three reasons: Your client is covered for more losses (e.g., water damage to walls and ceiling from roof leaks), your client has improved coverage for losses subject to the master policy deductible, and you broaden the HO-6's loss assessment coverage to special perils from named perils.

6) Add special perils contents coverage (to cover damage to personal property from roof leaks, paint spills, etc.).

7) Add sewer backup and sump pump failure coverage. You want to do this for two reasons: first, to cover direct damage to the unit or contents from these two perils; second, to broaden the loss assessment coverage to include assessments for either peril. (loss assessment coverage applies only to assessments for losses from perils covered by the HO-6.)

8) Determine the need for flood or earthquake coverage.

9) Recommend that your client buy adequate liability coverage (e.g., $500,000) in limits equal to the client's other personal liability coverages.

10) Urge the client to buy an umbrella policy. Be sure it includes coverage for association volunteer activities, including non-profit D&O, in case your client ever serves on the board.