Tip of the Month June 2007- Condominiums
Condominium Associations
Boards of Directors of condominium associations typically are responsible under their by-laws for maintaining all forms of property insurance necessary to protect the common property of the association against all hazards to which that property is exposed for either the insurable value (replacement cost) of those common building elements. Boards would be well advised to include their attorneys, as well as their agents, in coverage considerations, because insurance requirements are driven by by-laws and can be affected by state regulations.
This responsibility would typically include providing adequate flood insurance protection for all common property located in high flood risk areas called the Special flood Hazard Areas (SFHAs). Such association document requirements could make the individual members of the boards of directors of associations personally liable for insurance errors or omissions, including those relating to flood insurance. It would be prudent to determine whether the Directors and Officers (E&O) policies provide for such coverage.
Unit Owners
Condominium is that form of ownership of real property in which each unit owner has an undivided interest in common elements. Therefore, unit owners in apartment style condo buildings have a financial interest in the condominium building, as well as, in the building elements within their unit. Obviously, a unit owner can’t insure the entire building, but can encourage the condominium association to purchase adequate flood insurance protection for the entire building. Flood insurance protection for eligible residential buildings and building elements within individual units is most cost efficiently managed by the condominium association under the Residential Condominium Building Association Policy (RCBAP).
Condominium unit types include detached single-family dwellings, townhouses, rowhouses, or units within a high-rise or low-rise apartment type building, which are considered to be single-family residences by the National Flood Insurance Program (NFIP). Townhouses or rowhouses individually titled and single family structures would be insured under the Dwelling Policy in the name of the building owner.
Unit owners, who may be individuals or associations, have unique coverage needs that merit particular care. Owners should obtain information about the by-laws and building coverages already provided by the association, because such coverage would be primary, while the unit owner’s coverage of building elements is excess. The assistance of their agent is needed to coordinate the appropriate coverage combinations. The two policies that address the insurable needs of residential unit owners are the RCBAP and the Dwelling Policy, explained below.
Insurance Agents
When calculating flood insurance coverage, the same general business practice, which is used for hazards other than flood, should be employed. In addition, the replacement cost of the building foundation and its supporting structure should be included in the calculation, as it is covered under the RCBAP and typically excluded under private commercial policies. Agents should review coverages periodically to ensure that they are adequate, because the Standard Flood Insurance Policy forms RCBAP, General Policy and Dwelling Policy do not include a mechanism that automatically increases the coverage amount to address increasing construction costs due to inflation.
See the Rating Section of the Flood Insurance Manual for maximum building and contents limits applicable to the policy form.
Deductibles apply separately to buildings and contents coverage. Contents coverage can be purchased separately, or added to all policy forms for an extra premium.
Lenders
Federal financial institution regulators state that the amount of flood insurance purchased for a structure in a high-risk area must at least equal the outstanding principal balance of the loan, the insurable value of the building, or the maximum amount of coverage available for the particular type of building under the NFIP, whichever is less. However, the lender may exceed the minimum requirements, if necessary, and compel the purchase of limits that more fully protect the lender and the property owner.
Land is not insurable. Therefore, insurable values of buildings do not include land values and can be determined with the help of property insurance agents. Appraisals that include a current separate replacement cost (cost to reconstruct) for a building are also an appropriate measure of insurable value of buildings. Market values of buildings include uninsurable elements, such as land and property location, and if selected as the insurance coverage cause the property owner to pay flood insurance premiums beyond the necessary amount.
The Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae), when purchasing loans on the secondary market that are secured by properties located in high-risk areas, may have more specific requirements. Lenders should review the Mandatory Purchase of Flood Insurance Guidelines booklet, for information concerning secondary lenders and compliance requirements applicable to the NFIP.
Although Federal mandatory purchase laws apply to lenders, the practice of the lending industry, as followed under the RCBAP, is to defer to the association to ensure compliance. The association does not bear mortgage responsibility on the individual units, however, its interest springs from the obligation to maintain and repair the premises for the community benefit and unit owners as tenants in common. A key feature of the condominium insurance format is the separate ownership and mortgaging of the individual units, yet the insuring of the building, as a whole, is with a policy issued to the association only. Because the RCBAP provides flood insurance coverage protection for both the individual units and the common elements of the building, the security interests of individual unit owners and mortgagees should be protected, so long as the amounts reflect insurance to value, as with other forms of property insurance. Lenders are still responsible to meet their compliance requirements under the law.
If the lender determines that coverage purchased under the RCBAP is insufficient to meet the mandatory purchase requirements or if there is no RCBAP, the lender can request the borrower to ask the association to carry adequate limits or require the purchase of separate unit owner’s building coverage under the Dwelling Policy Form. Although a Dwelling Policy purchased by the unit owner would satisfy the minimum mandatory requirements for federally regulated lending, the lending institution and unit owner assume unknown possible exposures. For example, following a major flood loss, the insured unit owner would have to rely upon the association’s and other unit owner’s financial ability to make the necessary repairs to common elements in the building, such as electricity, heating, plumbing, elevators, etc. Recovery could be lengthy and the unit owner may incur additional
Residential Condominium Building Association Policy Form
The RCBAP Form is specifically designed for buildings owned by condominium associations that have at least 75% residential occupancy and are located in regular program communities. High-rise and low-rise residential condominium buildings and timeshares (fee or real estate ownership) located in regular program communities can be insured under the RCBAP. Residential condominium buildings that are being used as a hotel or motel, or are being rented must be insured on the RCBAP, if in a regular program community with 75% residential occupancy. The RCBAP enables the association to manage flood insurance needs according to their insurance requirements, which typically require insurance to value. Under the RCBAP, the entire building is covered, including the common areas, individually owned building elements within the units, and personal property owned in common, if contents coverage is purchased. Loss settlement under the RCBAP is on a replacement cost basis, meaning that the RCBAP is not subject to a deduction for depreciation. However, it should be insured to full Replacement Cost Value (RCV), or up to the maximum available limits of $250,000 per unit times the number of units, whichever is less. Buildings that are not insured to at least 80% of their replacement cost, or the maximum amount of insurance available for that building under the NFIP, at the time of loss, would be subject to a co-insurance penalty. The co-insurance penalty could considerably reduce the amount the association would be entitled to, forcing them to have to make up any such shortfall either by using reserves or having to levy special assessments on individual unit owners. In addition, when such underinsurance occurs it will negate any assessment coverage under the Dwelling Policy. Please review the Examples of flood loss assessment against unit owners and settlement outcomes in Section D of the Mandatory Purchase of Flood
Insurance Guidelines. Examples for avoiding the coinsurance penalty are available in Section D of the guidelines booklet.
The RCBAP benefits to associations and unit owners include:
- Convenience to associations that can obtain coverage for buildings without having to rely on the actions of individual unit owners.
- Cost savings to unit owners, because the RCBAP premium is proportionately lower cost than each unit owner’s premium if individual policies are used to protect the building, in the absence of an RCBAP.
- RCBAP reduces complaints against associations.
The General Property Policy Form
The General Property Form is used to cover residential condominium buildings that are not eligible for coverage under the RCBAP, non-residential condominium buildings and other ownership types such as, cooperatives, non-fee interest timeshares (right-to-use timeshares).
The maximum amount of building coverage available under the GP is $250,000 for residential buildings in regular program communities and $100,000 in emergency program communities. Owners of timeshare buildings that are non-fee interest, such as right–to-use and owners of residential cooperative buildings, would utilize the GP Form up to the maximum available coverage limits. Cooperatives and timeshare buildings with 75% residential occupancy are defined as residential buildings under the NFIP.
Contents Coverage
Owners of residential condominium units located on a regular program community can purchase contents coverage for heir personal belongings. The maximum amount of contents coverage available is $100,000 for residential buildings located in regular program communities and $10,000 in emergency program communities.
Non-residential condominium associations can purchase building and commonly owned contents coverage in the name of the association under the General Policy Form up to $500,000 for buildings and $500,000 for contents.
Owners of non-residential condominium units, located in a regular program community, can purchase contents only coverage up to $500,000 and can apply 10% of the contents coverage limit towards flood damage to interior walls, floors and ceilings. The 10% is not an additional amount and reduces the contents coverage.
The Dwelling Policy Form
The Dwelling Policy Form can cover building elements within residential condominium units, improvements made by unit owners, flood loss assessments and personal property owned by the unit owner or only the personal property of unit owners.
The Dwelling Policy Form can not be used to meet coverage shortfalls in the RCBAP that apply to co-insurance and deductibles. Single unit coverage cannot exceed the $250,000 building coverage limit that applies to single-family dwellings, in regular program communities, or the $35,000 building coverage limit, in emergency program communities. In summary, the combined portion of the association’s building coverage that pertains to a single unit and the building coverage purchased by the same unit owner to cover the building elements may not exceed the $250,000 maximum in regular program communities or $35,000 in the emergency program communities. Again, it is important that the unit owner obtains information about the association by-laws, and existing coverage, which would be primary. It is wise to seek the assistance of an agent who is familiar with the NFIP.
Coverage options for improvements within units made by residential unit owners:
- If the condominium unit owner purchases contents coverage under the coverage is also available for the interior walls, floor and ceiling, if not otherwise covered under the flood insurance policy purchased by the condo association, up to 10% of the contents limit. Use of the contents coverage for improvements is at the discretion of the unit owner and reduces the personal property limit.
- Owners of cooperative and timeshare units that are non-fee interest, right-to-use, where no deed is held by the unit owner, can purchase contents only coverage under the Dwelling Policy Form. If necessary, up to 10% of the contents coverage limit can be applied to improvements made by the unit owner. Use of the contents coverage for improvements within the unit is at the discretion of the unit owner and reduces the personal property limit.
Building losses are generally settled on the ACV basis under the NFIP. The RCBAP has its own loss settlement provision previously explained. Building coverage under the Dwelling Policy is settled on a replacement cost basis, meaning that it is not subject to a deduction for depreciation, only when it meets the requirement one and two below:
- The Dwelling Policy “Building” coverage settlement on a Replacement Cost basis is applicable to a single family dwelling that is the principal residence, which means that, at the time of loss, the insured or spouse lived there for at least 80% of the 365 days prior. Or, the period of ownership if less than 365 days.
and
- At the time of loss, the amount of insurance on the building is 80% or more of its full replacement cost immediately before the loss, or is the maximum amount of insurance available under the NFIP.
Contents coverage is always settled at ACV
Note: Coverage limits under the NFIP for buildings and contents can not exceed the insurable value of the building or contents, as with other lines of insurance.
Examples of flood loss assessment against unit owners and settlement outcomes:
Example A - no RCBAP
- If the unit owner purchases building coverage under the Dwelling Policy and there is no RCBAP the Dwelling Policy responds to assessments against unit owners for damages to common areas up to the dwelling limit.
- However, if there is damage to the building elements of the unit as well, the building coverage limit under the Dwelling Policy may not be exceeded by the combined settlement of unit building damages, which would apply first, and the loss assessment.
Example B - RCBAP insured to at least 80% of the building replacement cost
- If the unit owner purchases building coverage under the Dwelling Policy and if there is a RCBAP insured to at least 80% of the building replacement cost value, the loss assessment coverage under the Dwelling Policy form will pay that part of a loss that exceeds 80% of the association’s building replacement cost.
- The loss assessment coverage under the Dwelling Policy will not cover the association’s policy deductible purchased by the condominium association.
- If building elements within units have also been damaged, the dwelling policy pays to repair building elements after the RCBAP limits that apply to the unit have been exhausted. Again, coverage combinations cannot exceed total limit of $250,000 per unit.
Example C –RCBAP insured to less than 80% of the building replacement
- If the unit owner purchases building coverage under the Dwelling Policy and there is a RCBAP that was insured to less than 80% of the building replacement cost value at the time of loss, the loss assessment coverage can not be used to reimburse the association for its coinsurance penalty.
- Loss assessment is only available to cover the building damages in excess of the 80% required amount at the time of loss. Meaning, the covered damages to the condominium association building must be greater than 80% of the building replacement cost at the time of loss before the loss assessment becomes available. Covered repairs to the unit, if applicable, would have priority over loss assessments under the Dwelling Policy.
