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Landlord Insurance Coverage ExplainedLandlord Insurance Coverage Explained

Coverage Options & Strategy Explained For Owners

Landlord Insurance coverage is most commonly obtained on a property by property basis.  That is, each property has or carries its own policy of coverage for most landlord insurance coverage buyers.  On accounts where the number of properties increases beyond (say) ten 1-4 units properties, then there may be other policy options to amass all the locations into one larger contract covering all the addresses involved.  The benefit of a single policy for your landlord insurance coverage is convenience and uniformity of coverage.  The one primary disadvantage is having all your eggs in one basket.  If one property becomes ineligible or uninsurable within that policy, then sometimes all the property is no longer eligible.

There are four broad and important areas of concern for a landlord in insuring his property and liability.  They are:

  1. Insuring the building property – Limits and Valuations
  2. Insuring the personal property – Appliances and Service Equipment
  3. Insuring the Loss of Rental Income – Protects your income stream after a loss
  4. Insuring the liability exposures – Protecting you, your property, and other assets from attachment

We’ll deal with these landlord insurance coverage issues by exploring each of the latter topics as separate issues.

Insuring the Building:  Determining Valuation Method, Setting Insurance Amount

The primary area of concern in insuring the structure is to settle on an amount of insurance in the landlord insurance coverage policy.  But, that is easier said than done.  Insurance coverage is not subject to the market influences that impact property valuation so the fact that you got a great buy due to a depressed home and dwelling marketplace is your good fortune but, doesn’t enter into the conversation about how to insure your property.

Insurance underwriters and claims adjusters are going to concern themselves with either replacement cost or actual cash value.  As we talk about these two we also need to understand co-insurance and the 80% insurance to value requirement.  In landlord insurance coverage the real estate crisis of the past 5-7 years has pointed out the variations between reconstruction costs, depreciated settlements, and market value as it relates to buildings of all kinds.  I don’t think we can leave this topic without a brief explanation of how each of the latter applies to your property.

Market Value for Landlord Insurance Coverage

Market value means the price for property in a free and open marketplace.  Some in the real estate business call this an “arms distance” transaction, where the buyer and the selling are motivated by their own interests and have found mutual agreement on terms satisfactory to each.  If you bought a property at the sheriff’s sale, the Sheriff sold the property to satisfy a tax arrearage.  These circumstances aggravate “arms distance” theories because the owner lost the property involuntarily.  On the other hand, If you bought a house from me, I agreed to the purchase offer by you because I was satisfied with the purchase amount and the terms of sale.  Arms distance relationships work in to make an honest marketplace.  When a glut distressed properties are in the marketplace due to economic circumstances driving down costs of acquisition is not more relevant as an indicator of cost to repair or rebuild (and it doesn’t change the fact) that you were willing to pay me more for my property because of scarcity.  These type circumstances are not appropriate as a way to set a value for a property.

Actual Cash Value and Landlord Insurance Coverage

Actual Cash Value enters into every insurance conversation even if you have purchased coverage on a replacement cost basis.  The common definition of actual cash value (ACV) means “the cost to repair or replace the damaged property less deductions for physical deterioration (depreciation) and obsolescence.”  ACV is important because it recognizes the diminished value of a property through time because of wear and tear and diminished useful life. ACV, as a basis of determining the value of your loss, is the very common as a method of settling losses.  It is the basis of the valuation if you choose to walk away from a property with cash in hand because paying “replacement cost” would reward you for having a loss under those circumstances and this violates principles that make insurance a viable mechanism to transfer risk of loss.  Replacement cost calculations are at the start of determine ACV.

Replacement cost and Landlord Insurance Coverage

Replacement cost is the standard of coverage on most property policies but replacement cost coverage may not be appropriate for properties that are very old or acquired for much less than the cost of reconstruction.  In instances where insuring the property at the replacement cost value is unworkable or unaffordable because of the cost to reconstruct, actual cash value (ACV) coverage may be the only choice.  ACV settlements strike their hardest penalty on property owners in the small, repairable losses where the subtraction for depreciation will impact the settlement after a loss is calculated.  We offer coverage with carriers who can apply a “repair cost” endorsement.  This endorsement helps eliminate the ACV depreciation penalty in circumstances where repair is possible and the building isn’t a total loss.  As for defining replacement cost, the common sense definition is that the insurer will permit repair or reconstruction of the damaged property with materials of like kind and quality, without a deduction for depreciation.

Older properties again create problems.  Older homes are probably constructed with materials and methods of construction that are no longer used or permitted under law.  Balloon frame construction methods may not be allowed under local laws, as an example.  This style of construction may not meet the structural requirements in many jurisdictions and the methods of construction need to be modernized.  Most local jurisdictions require the issuance of a building permit and zoning and building ordinances have changed enough to make even 50 year old homes outdated in numerous ways.  When it comes to Landlord Insurance Coverage, the older the property the more likely the methods of construction and the material change will be forced upon you by building codes.  All of it is for good reasons.  Replacement cost does not include the cost of updating a home to modern code specifications.  There is a coverage that is sometimes available called “ordinance and law” coverage that is designed to assist in the additional costs of upgrading a property to meet current codes.  This may happen from electrical, plumbing, framing, to the HVAC and other things.

Older properties will also have problems replacing materials economically.  For example, plaster and lathe was the common method of surfacing a wall area and both plaster and lathe methods are no longer generally available.  The common replacement is called drywall, a formed sheet of gypsum sandwiched between two heavy pieces of paper.  Decking for floors and roof use OSB (oriented strand boards) that are wood strands and fibers impregnated with a heavy dose of glue and heated and pressed into sheets.  Plywood is a similar product but less common as a decking material anymore.  Old homes used dimensional planks to deck floors and roof and this is both impractical and expensive to modify.  Typical dimensional lumber today is the 2 x 4 (and similar measurements) and they measure about 1.5 inches by 3.5 inches (not 2 x 4).  This is called nominal width, the width after machining to size the lumber.  Planks used in 100 year old homes were often eight quarter (8/4) material that was a full two inches thick.  That kind of material is rarely found on a construction site today so the age of the home is an issue to consider on Landlord Insurance Coverage.  OSB is the material of choice because it is quick to install, ubiquitous, and meets all applicable codes when applied in the correct thicknesses to floor and roof decks.  You’d never reinstall the unsafe “knob and tube” electrical system so it is also just as reasonable to presume that “functional replacement” of building materials and components would be a similar move for repair or reconstruction.  That is why replacement cost on old homes, ornate in detail and complexity, and packed full of 19th century building technology, are almost impossible to rely upon or to create (even though we do try hard to arrive at reasonable numbers).  That is why ACV as a valuation method is chosen for old residential properties.

Landlord Insurance Coverage and Co-Insurance

No conversation about property insurance valuation would be complete without understanding the 80% co-insurance requirement contained in the ISO DP 00 03 12 02 Dwelling Property 3 policy.  Co-insurance is a concept that many of my customers find difficult to understand.  Let me try to explain.

Co-insurance stems from assumptions made in the rate making and policy writing process.  All rates formulas include assumptions.  The assumption about “co-insurance” is that the carrier is basing their rate making formula on the assumption that you will buy and maintain coverage of at least 80% of the full replacement cost for your dwelling on the Landlord Insurance Coverage.  This assumption exists because of another facet of the formula.  That formula concept basically says that as the insurance to value ratio goes down , the risk that the rate being generated in the formula is an incorrect indicator of the risk the company is undertaking goes up.  Put another way, the lower the percentage of the property that is insured, the greater the risk that the carrier will have to write a check to settle the loss paying full limits.  Landlord Insurance Coverage is rated on similar formulas to other property insurance policies including homeowner insurance.  Think of insurance coverage as $10,000 layers or bands of susceptibility.  Of course, the first $10,000 of coverage is much more likely to be paid because the number and type of losses that can equal this amount are greater than the risk of a total loss.  The next $10,000 is less likely than the first $10,000 to be subject to payment in a loss, and so on.  The farthest dollars from the first dollar are not nearly as likely to be paid in a loss when measured in loss results.  In other words, total losses are rare, partial losses are common.  All that a carrier is saying is that if you maintain at least 80% insurance to value (to the total cost of replacing your dwelling structure), there is no penalty – we’ll pay up to the limits purchased on the policy.  If you fall into a co-insurance situation, your loss is settled on a ratio of co-insurance.  If you needed $80,000 to be excused from the 80% co-insurance clause, on a $100,000 replacement cost, but only had $50,000, you are a co-insuring with the company to protect them from adversely selecting against their rate making formula.

How it works out is detailed in this formula.  The amount you had in insurance ($50,000) is divided by the minimum amount you should have had ($80,000) calculates and you are a 63% co-insurer ($50,000 divided by $80,000 = 63%).  You will get $63 for every $100 lost, with the difference being your portion of the loss since you were a co-insurer on the loss.  Every other term still applies and this includes the deductible.  The co-insurance provision applies similarly to ACV loss valuation but ACV gives you a far lower coverage requirement than would replacement cost on an old and ornate structure.

Personal Property – Landlord Insurance Coverage

In Landlord Insurance Coverage, the discussion above about valuation and the building valuation has application here on the personal property as well.  The appliances and lawn and property service equipment are property you should make sure are included.  Ten units of appliances could be $20,000 or more and it doesn’t make sense to leave these off the policy.  Make sure to ask your agent if the personal and service equipment are included as service property under the dwelling amount or if an additional limit of coverage should be added to the policy coverage.  I am aware of some policies that include a small amount of personal property coverage as part of the policy package but generally speaking, you should add this coverage if you desire coverage.

Additional Buildings on the Property

Older residential dwellings often include a detached garage or other appurtenant structure.  The Landlord Insurance Coverage is ala-carte coverage.  You need to buy the coverage you need.  Occasionally, there are guest quarters in a separate building and these may require specific coverage.  Under the ISO DP3 dwelling policy form you are permitted to use up to 10% of the Coverage A (Dwelling) limit for additional structures so if the additional structure exceeded this value then you should specify a value for this additional structure with a limit of insurance.  The same policy coverage (causes of loss) apply to separate structures on the property.  If there is a commercial or farming purpose for the additional buildings or if the structures are rented to others for any purpose other than as a private garage, then this extension of coverage does not apply.  You may still be able to amend the policy for coverage so check with your carrier or ask your agent for your options.

Fair Rental Value – Loss of Rents on Landlord Insurance Coverage

If the protection of the Landlord Insurance Coverage policy applies to a loss to the dwelling, additional structures, or the contents you own in the dwelling, you have the benefit of rental coverage when you use rental income.  Some companies limit this automatic coverage for loss of rent to 10% of the coverage amount on the dwelling.  There are conditions that may apply and you are entitled to only the portion of income in a building that you actually lose after subtracting non-continuing expenses and the coverage applies only so long as necessary to put the property back in business.  Loss of rent does not cover the income lost because of a cancellation of a lease or rental agreement and a covered peril must have first damaged the property for rental coverage to apply.

Liability in the Landlord Insurance Coverage

Depending upon the number of dwelling units you own, coverage for Liability can be accomplished by covering the liability in three ways:

  1. Add the coverage to existing homeowner policy by adding the location.
  2. Add the coverage to the Landlord Insurance Coverage as an additional coverage.
  3. If you have a large number of units, add the coverage to a commercial general liability policy.

Landlord Insurance Coverage should provided liability protection over every owned location and should include personal injury coverage regardless of from where it is provided.  Personal injury coverage relates directly to the business of renting homes because it provides protection for slander, invasion of privacy, and wrongful eviction among other protections.

Liability is probably the single largest exposure to loss for a person renting property.  Defending liability claims usually requires hiring legal representation and this makes liability expensive before a finding of negligence is ever determined because you will find legal representation costs $250-300 a hour as the defense is made.  Liability insurance when added within the Landlord Insurance Coverage will provide and pay for the legal defense when claims of negligence are made against you.  If you ultimately lose the claim in a court of law or when negotiations conclude your responsibility, it will also pay the loss up the limits of liability you select in addition to whatever was paid in providing a defense against the claim.

Another thing that makes liability a crucial area of concern is that liability is subject to a lot of influences outside of exactly what happened.  For example, juries, lawyers, witnesses, and judges all have a role to play and that makes absolving you of liability difficult to predict regardless of what actually happened.  Injury claims are also subject to the intangible of sympathy for the victim or injured party.  Because of the open-ended nature of liability claims it is important to buy more coverage than you might otherwise every expect to need.  Adding an umbrella might be a good idea.

Landlord Insurance Coverage is a product we have lots of experience with.  I have spent almost my entire 37 year insurance career working with and insuring small business clients and landlords of many types and sizes.  I maintain regular office hours Monday – Friday and from 9 – 5 most days for your convenience.  If those hours won’t work, call and schedule time with me that is mutually convenient at most other hours of the day and week.  You can reach me at (513 779-7920.  I have listed many of the most popular business classes to the right on this page.  Click on the link and you will be taken to the page that relates to that business type for specific information for that category of business.

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