Appraisals Can Keep Insurance Premiums Down

Homeowners elect the Board of Directors of a community association to fulfill many duties, including compliance with the Michigan Condominium Property Act, enforcement of the rules of the association as described in the Bylaws or Declaration, maintenance of the association’s commonly owned property, and helping to maintain the financial stability of the association, to name a few.

Board members are fiduciaries of their association, which typically are non-profit corporations. This means that individual directors assume many of the same responsibilities as those serving on the Board of Directors of such corporations as Kmart or Ford Motor Company. More often than not, boards seek out the independent expertise of others to help them conduct the business of the association. The board often uses experts in property management, accounting, engineering, and law.

The American Institute of Certified Public Accountants (AICPA) Audit Guide for community associations states that the association’s ‘primary duties are to maintain and preserve the common property’. The Michigan Condominium Property Act requires every condominium association to obtain insurance for the property. Thus, board members have a fiduciary responsibility to reduce the risk of financial loss from unexpected events that result in damage or physical loss.

How Much Coverage Is Enough?

After an association is turned over from the developer, the new independent board may unintentionally over- or under-insure the property by continuing the coverage that was placed by the developer. Developers can overinsure by insuring property not normally insured following completion of construction. This includes foundation or retaining walls, and underground piping and utilities. Conversely, a developer may underinsure by omitting property thought to be insured by the homeowner. Associations will often ask an insurance agent or broker to help them determine and place or obtain the appropriate amount of insurance. However, the agent usually informs their client, the association, that they are not independent experts in determining the appropriate limits of insurance.

Boards should not rely completely upon the agent or broker to determine property values due to a possible conflict of interest. Remember, the replacement cost of the property determines the insurance premiums that you pay. Rather, an independent opinion of property value best qualifies the appropriate limits of coverage.

Associations should have an independent appraisal of the property to determine accurate replacement costs of the insured property. Boards have a greater confidence in a qualified appraiser’s opinion because the appraiser has nothing to gain or lose by the amount of coverage.

What Is an Insurance Appraisal?

An appraisal is an independent, supportable opinion that serves to establish insurance values and help expedite claims in the event of a partial or total loss. Replacement cost is defined as the amount required to reproduce the entire property at one time, in like kind and materials, in accordance with current local, site-specific market prices for materials, labor, and manufactured equipment, contractors’ overhead and profit, and fees, but without provision for overtime, bonuses for labor, and premiums for material or equipment. The appraiser also considers the observed quality of construction, materials, design and workmanship.

Why Get an Appraisal?

Insurance premiums are a significant line item in the operating budget. Insurance agents and brokers base their competitive bids to insure the property in part on the insurable value of the property. Sound business judgment suggests the necessity to base each bid on the same level of property value. An initial and periodic independent insurance appraisal confirms the appropriate amount of insurance. In addition to determining accurate replacement costs, an appraisal segregates the property into areas of responsibility for insurance, i.e., the association or homeowner. The association should not incur insurance costs for property for which it is not responsible. Your association may also lose without an appraisal because:

1) Trending the insurance values up each year may result in inflated replacement property values, which means you’re paying too much in premiums. Building material and labor rates fluctuate from year to year.

2) Conversely, if your insurance values are too low, you may be unknowingly self insuring, which, in the event of a loss, would have disastrous consequences, requiring homeowners to pay a portion of the cost to rebuild. (Directors and Officers liability insurance does not cover losses because of underinsured property.)

The benefit to the association is that you’ll have documented support in the event of a partial or total loss. An independent, supportable insurance appraisal is your key to expediting claims with insurers. The real value to the homeowners is that they’re paying the proper amount in insurance premiums, neither too much nor too little.

Common Elements Typically Included/Excluded

The board should make certain that the appraisal, and hence, insurance policy covers only those items for which the association is responsible. Insurance policies for associations typically include:

  • Exterior perimeter walls
  • Structural frame and floors
  • Interior ceilings, walls and partitions up to the finish on the ceiling and wall
  • Plumbing and domestic water supply system
  • Electrical receptacles, switches, panel boards, wiring systems, exterior electric lighting
  • HVAC systems (heating, ventilating, and air conditioning)
  • Cabinetry

Exclusions are property items that are normally excluded from insurance coverage, such as:

  • Portions of foundations below the under-surface of the lowest basement floor or below the surface of the ground, where there is no basement
  • Furniture and movable equipment
  • Land Improvements including paving and walks, curbing, driveways, fencing, landscaping, roadways, reservoirs, culverts, trenches, retaining walls
  • Below ground piping and power supply wiring and electrical devices
    Landscape sprinkler systems

Homeowner Insured Property is just that – property that the association should not include for insurance replacement purposes because it is the responsibility of the homeowner to insure.

Examples include:

  • Interior finishes on walls
  • Floor and ceiling finishes including paint, wall paper, tile, carpet, vinyl flooring or other attachable finishes
  • Plumbing system fixtures serving only an individual unit
  • Electrical fixtures within an individual unit
  • Appliances

However, some policies, declaration or by-laws require the insurance of some or all of these typically homeowner-insured items of property. Each association is different and needs a separate analysis to determine the appropriate limits of coverage based on the inclusions and exclusions of association insured property.

Is Full Replacement Coverage Right For Us?

Guaranteed Full Replacement coverage is a type of insurance policy that offers full replacement regardless of the size and amount of the loss. This type of policy is effective in ensuring that the association is not under-insured. However, there are some concerns the board should consider.

  1. Identify the property values that are used in the policy from your agent or broker and compare those values with the appraisal. In some cases, guaranteed full replacement policies rely on overstated limits of coverage, which may result in excessive premiums.
  2. Guaranteed full replacement policies generally state that the insurer will provide the necessary funds to ‘reproduce the property in like kind and materials.’ Replacing the wood floor in the lobby may mean a parquet floor to you, but plywood to the insurance company.

Shop Around

The board should review the association’s insurance policies each year. Independent appraisals can often help to reduce your property insurance premiums and save the association money year after year.

Compare the appraised insurance values of your association with your current policy. If the appraised value is less than the existing limit of coverage, the board should seek a premium reduction or put the policy out for competitive bidding. However, if the appraised value is more than the existing limit of coverage, the board should increase the amount of insurance, again putting the policy out for competitive bidding.

Shop around every few years. Rates and coverage are constantly changing. The insurance industry has not grown significantly during the 1990’s. As a result, some insurance carriers have taken a more aggressive marketing approach to obtaining new business with attractive, low premiums.

The appraiser should update your appraisal annually. An appraisal identifies replacement costs as of a specific date. Economical updates (generally only about 10% of the cost of the original appraisal) help to ensure the accuracy of the association’s property values. Changes in replacement costs can result from many factors, including technological advancements in product design, construction methods and materials. Labor rates, a significant factor in determining replacement costs, will fluctuate over time, due to the supply and demand of housing.

Independent insurance appraisals help boards fulfill their fiduciary responsibility by protecting the association from partial or total losses with appropriate coverage, and saving the homeowners money over the long run.

Ted Salgado, P.E. is a principal in Reserve Advisors Inc., which conducts Reserve Studies and Insurance Appraisals exclusively to Community Associations in 28 states. He is a professional engineer and has appraised residential and commercial real estate since 1976.