Many community associations have inquired over the years as to whether they should buy earthquake insurance, considering that the costs fluctuate so much and at times are quite high. After networking with attorneys all over the state of California that had to deal with the problems involving reconstruction, collection of special assessments, and disputes with insurance companies in the aftermath of the Loma Prieta and Northridge quakes, I have come to believe that associations should purchase earthquake insurance if they can get it, even if the price is high.
The Value of Earthquake Insurance
The reason: Associations that did not have coverage experienced severely exacerbated problems, and many did not recover. The homeowners who wish to rebuild and keep their homes are the biggest losers when there is no insurance. The ones who purchased with little invested are the “winners”—they tend to walk away and leave the others with the full burden of rebuilding. Why not spread the risk fairly by engaging all of the owners in the development in preparing for “the big one”?
I have been asked since to speak to many associations about the considerations behind the decision to buy or not to buy, and I have shared the floor with insurance representatives who are able to find earthquake insurance, some even with a 10 percent deductible or a “per building” deductible (which is more desirable than a “per development” deductible) for a sum of money that is sufficiently affordable. By the way, my rule of thumb as to affordability in 1996-2001 when I first started writing about this was that an affordable master policy to be somewhere in the range of $400 – $600 per year per unit for homes priced in the neighborhood of $200,000-$300,000. In later years, with rising values in the median statewide market value of a home being more like $500,000 and up, I opined that the cost for master protection in the range of $1000-$1500 per unit per year to be affordable and worthwhile for the master EQ coverage.
I recognize that property values are deflated today but does that change my taste for risk? Not really. I base my thoughts on what I am willing to pay to get the coverage, given a condo I own on or near a fault. At this time in 2011 it is worth it is worth about $400,000, having ranged in value from $200,000 to $700,000 over the year; and I (like anyone else owning a condo) can cover my share in our association’s deductible which might (considering various alternative loss scenarios) be $10,000-$50,000 per unit through an earthquake policy purchased from the California Earthquake Authority (CEA). My share of an uninsured earthquake loss of $150,000-$400,000 (again, considering various loss scenarios), coupled with responsibility in a share for those who would not stay and pay, would probably cause me to lose the property; and I do not want to lose the property. There are certain to be many owners in any mature common interest development that have struggled to buy property and built up some equity, even in the current market. They deserve consideration.
The Risks of Forgoing Earthquake Insurance
A board has to take into consideration the interests of the community and not make decisions based on individual interests. It does not make sense to let those who have put little down on the property (who are more likely to oppose the coverage because their investment is small) dictate what protections to forego. Even if many are “underwater,” those who have worked hard to earn equity and want to stay and weather the recession and protect their interests deserve the benefit of some sharing of the risks by all other owners. Unfortunately for those owners who want the protection of master coverage, many boards, when they face the increases in the premiums for earthquake insurance, or cuts in coverage, or are bombarded in today’s economy by owners who have lost equity, lose their objectivity. The neighbor’s pleas or personal interests of directors (if they own an “underwater” unit) sway them. However, it is extremely important to consider the risks involved in saying “NO” to EQ coverage.
Those risks are:
- Lawsuits: If there is an earthquake, the board members and association could be sued and the directors and officers liability carrier would deny coverage because “failure to insure adequately ” is not a covered item, and guess who would pay to defend the lawsuits!
- Extra Costs Caused by the “Walk-Aways”: If the association has no coverage and there is an earthquake, owners “little invested” or without equity will likely choose to “walk away” leaving behind a trail of problems and expenses for those that stay. Even those that want to stay will have a very difficult time as losses will likely exceed amounts for which they can insure through available CEA “gap” coverage.
- “Stand Alone” policies are not what they seem: Private “stand-alone” (non-CEA) unit coverage which is purportedly being offered for individual homeowners whose associations are uninsured is not a solution for rebuilding, considering how difficult it would be to rebuild one single unit in a four, five or six unit building. Besides, from what I am told, the quotes given to owners for “stand-alone” earthquake coverage are astronomical; and some policies sold purportedly as “stand-alone” products will really only pay if there is underlying master coverage.
If your association’s CC&Rs require that the board purchase earthquake insurance coverage, then it should be purchased unless the CC&Rs are amended. If the association cannot bear the cost of the premiums or the board finds that the owners want a change, then an amendment should be put to a vote of the members. If it is not, then there is a fiduciary duty issue for failure to fulfill the obligation required by the CC&Rs. Ignoring the governing documents is not the answer. But I caution boards not to jump at the chance to eliminate the coverage or the documentary obligation without considering all possible options and doing some due diligence. In fact, the extent of the “due diligence” could well be a factor in defending a board that is sued.
Making the Prudent Business Decision
Here is something you might not have considered—educate the owners before taking a vote or saying “no” to master coverage so that you can get valid feedback from any survey or vote. Associations can bear high deductibles in the EQ master policies (which can equate to quite a savings in premiums) if owners are encouraged, possibly even required (by a CC&R amendment if needed) to purchase the CEA gap coverage. (CEA doesn’t call it that—it’s just a way of defining it as coverage that fills the gap opened up by the EQ deductible and other costs that might fall on individual owners in condos.)
The CEA offers residential policies to owners (called “Condominium” policies even if the development is townhouses or other common interest development attached housing) that cover personal property, building coverage for the owner’s unit, loss of rent and/or relocation costs, and perhaps most pertinent, loss assessment coverage that is paid to the owner to cover any association-imposed special assessment to cover the deductible or rebuild. One can purchase such an affordable policy even if the association does not have master coverage, and there are choices in the amount of coverage available, up to $100,000 for loss assessment in a condo valued at over $135,000. The policy would cover up to a $100,000 of one unit’s share in a deductible or, even if there is no master coverage, would be payable to an owner if the condo units are not rebuilt. The information on options and costs can be found on the CEA website at: http://www.earthquakeauthority.com. Since these are “residential” policies, they are less expensive than the “commercial policies” available to the associations. That is why it makes sense to give some thought to considering a higher deductible on the master policy – because it could be subsidized individually by owners with a less expensive residential “gap coverage” policy.
For example, the condo I own carries master coverage. It is a 100 unit condo on or very near a fault and the master policy costs each of us $450 per unit per year. I have a CEA policy to cover up to a $75,000 loss assessment deductible that costs me about $350 per year. For under $1000.00 per year on the combined policies, I could get up to $100,000 loss assessment coverage. If the majority of owners in any condo development were so “enrolled,” we could withstand a pretty considerable loss. If the development is totaled and not rebuilt, I could walk away with enough to pay the mortgage off and then some.
Boards needs to be willing to consider this as an option for the owners and to educate the owners of all the possibilities before saying “no.”
Of course I understand that economic times make it hard for people to bear extra expenses and thus have caused property values to be depressed to a point that there are more properties than ever “underwater.” But I also should point out that many owners have already or are in the process of walking away from “underwater” properties; and many of those coming in as new owners are investors. Why should they not share in the cost of protection for everyone else by sharing the costs of master earthquake insurance coverage?
All this said, for any association that is having difficulty getting earthquake insurance or that is having difficulty justifying the cost, boards, before you “Just say NO,” the following minimal steps should be taken. If there ever is a lawsuit for failure to push EQ insurance, it will be important to be able to argue that the decision was a “prudent business decision.”
The board of directors should investigate as follows:
- Obtain risk analysis for type of development and geological location.
- Procure multiple bids from insurance companies for earthquake insurance, or from an insurance broker who has access to several different companies.
- Educate and survey homeowners to see where they stand on the issue, providing them with meaningful facts and information the board has gathered including how they can protect themselves from high deductible gaps.
- Determine whether the costs involved would require an increase in regular assessments or special assessment that would require homeowner approval.
- Make a prudent decision as to whether to put any measure to a vote, or decline coverage, after gathering and considering the information as described above.
If the association wants to purchase earthquake insurance and the costs exceed legal limits for increases, then the association must go to the membership for approval under Civil Code Section 1366. The governing documents may require a stated percentage requirement for purchasing EQ insurance. Some boards might want to consider borrowing from the reserves to pay premiums, which requires specific steps and notice to owners and a plan to repay the reserves. It is good to get legal advice as to the requirements because there is some legal protection against individual liability for board members who consult experts when expertise is required to figure out the legal requirements.
For those associations waiting for a state program to bail you out, you can stop waiting. The California Earthquake Authority, and any other state program selling residential insurance policies, will not provide master coverage for associations because associations must purchase commercial insurance.
Whether or not to purchase EQ insurance is not the only question. Some associations are considering using the money that would otherwise be used to purchase earthquake insurance for retrofitting. If your buildings could benefit greatly from retrofitting, this might be an option. However, the above considerations still apply. Perhaps if an association must pay exorbitant amounts for layers of insurance to get full protection, there might be a feasible way to combine the purchase of minimal coverage with additional monies being spent on retrofitting. At least it would be something.
It is best to consult with your legal counsel and seriously discuss the legal ramifications, and consult with a knowledgeable insurance agent to discuss the options available, before turning your back on the question involving the purchase of earthquake insurance.
Beth Grimm is an attorney with offices in Pleasant Hill. She is a member of ECHO and various other industry organizations in California and nationally. She can be contacted through her website www.californiacondoguru.com. She was recently named by ECHO as the 2011 Volunteer of the Year.