Insure This
by Various Authors
Q. If a building had an illegal unit and a claim is filed due to fire, would the claim be rejected because of the illegal unit?
A. The claim would not be rejected simply because the room was illegal or built without permits. From the standpoint of the insurance carrier, the goal would be to put the owner back in the same financial position as before the loss; but this cannot always happen. The problem could occur when the owner attempts to get permits to rebuild and may not be able to get those permits.
The insurance carrier would likely offer a couple of options. If the city would allow the building owner to put back the same square footage that was damaged as an annexation to another unit, the claim would likely be paid for the full cost of such repairs. However, since a larger unit may not get as much rental income as two smaller units, there would be a loss of total rental income. Unfortunately, there would be no compensation for the future loss of rental value since the rental income coverage is only for the time it actually takes to rebuild, plus some additional amount of time—such as up to 180 days—in which to rent the space again after it is completed.
A side note on rental income is that the same situation of reduced income often occurs when a tenant with a higher than market rent lease is allowed to get out of that lease after damage to the building exceeds a certain percentage or specified time to rebuild and the landlord must then put it on the market at a lower rent. That particular exposure is rarely covered, although some carriers do have options to cover this. If you have such a situation and if the differential is high enough between the current rent and market rent, it may be worthwhile to check into carriers that offer this type of coverage.
If the building and permit departments would not allow any living space to be rebuilt, the owner could opt for a “cash-out” payment, which is usually offered on the basis of the actual cash value that is the used value of the building area that was damaged. The theory here is that if the insured does not replace the space, they are only out the “old” space and have no reason to collect for “new” construction. Depreciation in these cases is usually minimal though, as even old buildings have a long economic life—at least in the Bay Area.
A related situation can occur if the city won’t allow the building to be rebuilt at all at the present location. The used value cash-out is always an option, but some policies offer a better solution: they would allow the rebuilding of a similar structure at another premises. This way, the claim payment would be for the full cost of new, similar construction at a different location. Only a few carriers offer this coverage, so if you feel that in case of fire you would not be able to rebuild anything that would produce similar income to what you have, you may want to seek out one of these carriers, so that you would have the option to build offsite.
–David Gordon
Q. I own a 6-unit, soft-story building in the Marina and I can’t find any private insurance companies to provide me with earthquake insurance. Does the state-run California Earthquake Authority have to offer me this type of insurance?
A. The state-administered CEA earthquake policy is only available for residential structures that are 4 units or less. Apartment buildings exceeding 4 units are not eligible for the CEA policy.
Earthquake and wind/hurricane events are collectively categorized together as “Catastrophic Events.” Due to the fallout from Hurricane Katrina, earthquake rates have more than doubled this past year. In many instances, quake premiums in high-risk liquefaction areas, such as the San Francisco Marina district, have tripled.
A viable alternative to expensive stand-alone earthquake policies would be to join an insurance purchasing group such as CIBA (Commercial Industrial Building Owners’ Alliance). CIBA’s coverage form includes primary and excess liability protection, along with guaranteed replacement cost on property, with an optional 5% earthquake deductible; it’s the broadest coverage available in California. CIBA’s earthquake rates are currently substantially lower than most carriers.
For example, the CIBA premium for a 6-unit, $1 million replacement-cost apartment building in the Marina District of San Francisco for primary and excess liability, property and earthquake insurance combined (including loss of rental income) would be approximately $12,000 annually.
To be eligible for the CIBA earthquake endorsement, properties must be earthquake retrofitted. A qualified structural engineer must document that the building meets CIBA’s engineering underwriting requirements of a 30% probable maximum loss, and a 90% confidence level. The cost of obtaining an engineering report/certification is usually less than $2,000.
–David Costello
Q. What additional coverage should my apartment insurance program have?
A. As a landlord, your insurance policy protects you in the event of a catastrophic loss. Your basic commercial insurance program should cover your building, rental income and landlord liability. As you review your declarations page, you may find other line items providing some additional coverage. Based on your personal risk profile and insurance strategy—low cost or best coverage—you may want or need these additional limits to provide protection where you actually have the risk.
The most overlooked additional coverage that can be added to your current policy is business personal property. These are items added to an apartment building for functionality, but may not be considered part of the building in the event of a loss. Items like refrigerators, washer/dryers, blinds or any other items plugged in, placed or attached to the property are covered by the business personal property limits. A good rule of thumb is to use $2,000 per unit for standard apartments as an estimate for business personal property limits.
Based on your policy and your insurance strategy, you may have additional coverage within your policy providing coverage for trees, plants, and shrubs; valuable papers; account receivables; computers and technological equipment; personal property of others; money and securities; and much more. In many cases, these coverages are not thought of as single items you should claim against, but additional coverage in the event you have larger property loss.
Your commercial insurance program/strategy is different than a homeowner’s policy because commercial insurance carriers believe landlords should be able to cover most small losses themselves. In the event that you use your commercial insurance program as a maintenance policy, making many small claims, the current and future carriers will not be interested in providing you or the property with their best rates. The thought here is your loss history is a reflection of the property and the management. Many small claims on your loss history could indicate the property is in poor condition or the management is not actively maintaining the property. In either case, a small and frequent loss history is not a favorable report for the carrier.
In summary, the additional coverage provides the most benefit when you have a substantial loss. These additional limits can provide additional funds to bring the property back to its original condition. Although you may be able to make claims against each line item separately if you incurred a small loss, it is not in your best interest as it may reflect poorly on your loss history and prevent you from receiving the best rates for your property coverage.
–Paul C. Tradelius, Jr.
The opinions expressed in this article are those of the authors and do not necessarily reflect the viewpoint of SFAA or SF Apartment Magazine. Consult the advice of an insurance agent for any specific problem. David Gordon is an independent insurance broker who has been serving the needs of Bay Area property owners for more than 25 years. He is available at 877-877-7755 x 6972. David Costello is with NorthStar Risk Management & Insurance Services, Inc., and can be reached at 925-975-5900 x 228. Paul C. Tradelius, Jr. is with Commercial Coverage and can be reached at 415-436-9800. Copyright © 2007 by SF Apartment Magazine. All rights reserved.