September 2011 – Some HOAs are so large and their insurance premiums so hefty that they toy with the idea of self–insurance. Here, we explain what self–insurance is and discuss the risks.
Self-insurance sounds obvious, but there’s a minor twist. “HOAs are self–insured if they don’t have an insurance policy to cover them—that means they’ve decided to self–insure,” says Robert White, managing director of KW Property Management & Consulting in Miami, which oversees about 125 associations totaling 30,000–35,000 units. “They could also be considered self–insured if they have a policy, but it has an enormous void in it. There’s some set amount before it kicks in, so the HOA is self–insured for any amount lower than that number.”
Can You Self-Insure?
Whether your HOA can completely forego insurance or have high insurance minimums will depend on your state law and governing documents. “In Florida, HOAs and condos aren’t allowed to self–insure unless they follow complicated and restrictive requirements set forth by the state,” says White. “They’re also required to have a hurricane policy.”
Even if it’s permissible, our experts say HOA self–insurance is rare, except for optional insurance like earthquake coverage.
“I haven’t seen any do it, and we wouldn’t recommend pure self-insurance,” says Nathaniel Abbate Jr., a partner at Makower Abbate & Associates PLLC in Farmington Hills, Mich., who represents associations. “Most governing documents require the HOA to carry insurance in whatever level or for whatever coverage. If the HOA were to run a contract by us for painting, we wouldn’t ever accept a bid from a contractor who didn’t have insurance because the potential liability is open-ended. People can be destroyed by a catastrophe. Also, boards are held to the standard of a reasonably prudent person under the circumstances. I’d think no reasonably prudent person would say, ‘Let’s just take our chances and self–insure.’ That could even be viewed as a breach of your fiduciary duties.”
Duane McPherson, president of the western region and Dallas⁄Ft. Worth divisions of RealManage, an association management firm that oversees properties in Arizona, California, Colorado, Florida, Louisiana, Nevada, and Texas, has also never seen a self–insured HOA. “I do see a lot of them in California self–insure for earthquake insurance, which is extremely expensive,” he explains. “Many are instead putting whatever the premiums would be into reserves, and others have decided not do to it and are taking the risk of something happening. Also, some HOAs on hillsides have saved up reserves over the years in case something happens. But I don’t see any self–insured for anything else.”
Some Tinker with Insurance
However, some HOAs do try to tinker with their insurance to reduce premiums. “Pure self–insurance doesn’t work,” says Abbate. “But there are fewer and fewer association insurers in Michigan, and they have the right to raise their rates after any number of claims. So what does often get done is deciding to pay a claim out of your reserves rather than running the risk that another claim for something like ice dams is going to make your policy premiums go through the roof or be canceled.”
“Some associations are better off saying, ‘We have a high deductible, anyway, so let’s throw another $2,000 at this claim,” explains Abbate. “That takes care of the problem rather than having our insurance go up by more than that $2,000 or running around trying to find someone else to insure you.”
White has seen HOAs take a more risky tack. “I’ve seen HOAs and condos tinkering with their coinsurance percentage, a figure the insurance company uses to penalize you for not insuring to the full amount of your property’s value,” he says.
Coinsurance is a penalty an insurer imposes for underreporting or underinsuring the value of property, and the penalty amount is typically stated in the insurance policy. For example, assume a policy covering a condo building valued at $2 million, but insured for only $1.5 million, has an 80 percent coinsurance clause. If there were a $400,000 loss, under the complicated math insurers use, the association would recover only $375,000 (minus the deductible) instead of the full $400,000.
“The higher the coinsurance penalty, the higher the penalty you get in the event of a loss,” says White. “You could have a loss and not collect a penny. It raises the risk of the insured HOA for a little bit of lower–premium benefit. That’s something that might even require an owner vote because it’s so much of a material change from what owners would expect and because the savings doesn’t justify the additional risk.”
McPherson also believes it’s not smart to mess too much with your insurance coverage. “In the case of hurricane or earthquake insurance, I wouldn’t advise an HOA one way or the other,” he says. “That’s up to the association on how much risk it’s willing to accept. Also, if your HOA is single–family homes, there may not be a lot of risks. You may have a community room or something, and if you had to rebuild that for $100,000, it might be an acceptable risk.”
“But is it an acceptable risk to rebuild a $100 million condo building?” McPherson asks. “You also might save a little money by not having a directors and officers insurance policy. But all it takes is one lawsuit, and the directors and officers won’t be pleased with the results. Being self–insured for those things is going to come back and bite you at that point. Just bite the bullet and buy the right amount of insurance.”
Matt Humphrey is president of the Alameda, California-based HOAleader.com, from which this article was adapted.