Insure This
by Various Authors
Q. What is an insurable interest?
A. A person or entity has an insurable interest in something if loss or damage to it would cause that person a financial loss or an increase in liability exposure. As a building owner, you have an insurable interest in the building(s) you own because in the event of loss or damage to the property you will incur a financial loss to replace or rebuild what has been destroyed. However, others may also have an insurable interest in your property.
If you have a mortgage or other type of financing on the property, the lender will also have an insurable interest. Banks will loan a percentage of the building’s value, the mortgage will be underwritten by the building’s income and a property insurance policy will cover the building against loss or damage as well as rental income interruption. In the event of a covered cause of loss, your property policy will pay for the loss of rents and pay to repair or replace the property. In this case, both you and the bank have an insurable interest in the property because a loss or damage to the property will cause a financial loss to both you and the bank.
In this case, does the insurable interest of the bank equal the owner’s insurable interest in the property? Many times the answer is no. In the past, banks have required a policy limit equal to the loan value or the replacement cost of the property—whichever is less. The limits of insurance could be just enough to cover your loan value, but not enough to rebuild or replace your property. This requirement is not very desirable from your point of view because you could be underinsuring your property while only satisfying the insurable interest of the bank.
In today’s market, most of the hazard requirements issued by banks require limits of insurance equal to the loan value or the replacement cost of the property—whichever is greater. Therefore, if your loan value is less than your building’s replacement cost, you will be required to insure your property with enough coverage to rebuild or replace it. Now both insurable interests are aligned, as you will have sufficient coverage to replace or rebuild the building(s) in the event of loss or damage, and the bank will have coverage to ensure you will be able to replace the income-producing asset or pay off the mortgage. This is a win-win situation for all parties who have an insurable interest in the property.
—P.J. Tradelius
Q. If my rental property is damaged by fire and my tenants are forced to move out, would I be able to recoup the lost income?
A. In most cases, yes. The coverage at play here is “Business Income and Extra Expense.” This coverage can pay for the necessarily lost rental income and the extra expense to replace tenants (such as advertising and commissions to property managers for handling the rentals) after a covered loss to the building.
Most apartment building packages include this coverage; however, it is important to be aware of the limitations, as the coverage can vary between policies. The most common form of coverage is “actual loss sustained up to 12 months.” The good news about this type of coverage is that you don’t need to constantly review the limits as it only comes in one flavor—12 months. The downside is that if it takes longer than that to rebuild, you would likely not be covered for that additional lost income. Variations on this form are 18- and 24-month coverage limits.
Some policies provide for a specific limit of insurance, which is scheduled when the policy is written. With this coverage form, it’s important to review the limits annually, to ensure that you have enough coverage for your potential loss. With the specific limit, there is often a time limitation of 12 months; you need to be aware of this, too, as it’s of no value to insure for a higher amount based on a longer rebuild period if you are limited to 12 months as a maximum limit.
The broadest form of coverage is one that pays the actual loss sustained without regard to the dollar amount or the length of time it takes to rebuild. Only a few programs offer this broad form of coverage, but it does not cost much more with those companies who
A related question that often arises when this coverage is triggered is, “What if some of my units are vacant at the time?” The answer would depend upon things such as how long they were vacant and if there was a rental contract in place or close to being signed. Generally speaking, you would be covered for rent actually lost directly due to a tenant having to move out and not from the potential loss of a vacant unit that could have been rented. Consideration is given, of course, to units that likely would have been
The business income and extra expense coverage does not provide any coverage for the benefit of tenants, but many landlords are suggesting (and some even requiring) that their tenants purchase renter’s insurance. They remind their tenants that apartment building insurance carried by the building owner does not cover their own contents, liability or loss of use of the premises.
—David Gordon
The opinions expressed in this article are those of the authors and do not necessarily reflect the viewpoint of SFAA or San Francisco Apartment Magazine. Consult the advice of an insurance agent for any specific problem. P.J. Tradelius is with Commercial Coverage and can be reached at 415-436-9800. David Gordon is an independent insurance broker and has been serving the needs of Bay Area property owners since 1981 and is available at 877-877-7755, x. 6972. Copyright © 2006 by San Francisco Apartment Magazine. All rights reserved.