The History of an HO-6 Policy

Published in the ECHO Journal, July 2008

George’s Great Adventure

“What a wonderful day” thought George. He and his wife were finally getting out of the renting market and could call themselves homeowners. In just a few hours they would be closing the escrow on their new condominium, which was only eight years old. Yes indeed, this was a great day.

Once again he and his wife sat at the morning breakfast table and went over everything they were supposed to do, knowing that they had covered every little detail. But George was just that type of person; “everything right the first time,” he said to his wife, “and you don’t have to worry later.”

George and his wife drove to the title company office and met their realtor at 9:00 am sharp and promptly signed all the documents, making sure everything was explained to them in great detail. George even read all the documents that he had received from “Heavenly Management Company,” and felt assured that he had everything under control—yes sir, no mistakes in this purchase.

Shortly after closing, both the escrow officer and their realtor told them they needed to be sure and purchase their own individual “Condominium Owners Insurance Policy,” or HO-6, to cover their household belongings. “Wait,” said George “why am I just finding out about this now?” “Not to worry,” said the realtor; “it’s just a small formality and they are very inexpensive.” “Just go to your insurance broker, and he will fix you right up.” “But I thought the homeowner association had the master insurance to cover my condo,” said George. “Well, this is one item you need to clear up on your own because the association doesn’t cover your personal property—just the buildings in the association and the common area liability.”

George, being the ever-vigilante person that he was, left the title and escrow company and grabbed his wife’s hand and told her that they were going immediately to their insurance guy and immediately get that HO-6 insurance policy their experts said we need and that no one had told us about until now.

George and his wife drove to his insurance broker that he had used since he bought his first car 11 years ago and asked him about this “HO-6” policy he was instructed to buy. His broker said “Sure George, I can fix you right up with that; how much is your furniture worth?” George and his wife took a quick mental inventory and told him about $25,000. “OK” said the broker; he then quickly explained that if his condo caught on fire, his “stuff’ would be covered, and he would also get $100,000 in personal liability coverage included in his policy in the event he did something that got him sued. So George and his wife went merrily on their way, thinking they had done everything they could as new homeowners to protect themselves.

The short little story above is too often the outcome when a purchase is made in a condo or townhouse association. But in fact the process should be much more involved, and the association needs to assist the new homeowner in acquiring the proper insurance for his unit, based on the CC&R requirements, or how the association is insured.

Most insurance agents aren’t aware of the proper procedure to protect that new condominium owner and wind up issuing the standard “vanilla” HO-6 policy, when in fact the new homeowner needs a much more in-depth investigation by the insurance broker to determine his clients’ needs for their particular association.

My motivation for writing this article is directly related to my recent involvement as a consultant for an eight-unit fire loss in a 154-unit condominium association. When talking to each individual unit owner, I discovered that only four of the eight had an HO-6 policy and that none of those 4 policies had adequate building coverage to replace the interiors of their units. The other four believed they were covered by the associations master policy. The very sad part of that particular claim was that one of the burned-out unit owners was an elderly person who was not able to acquire the funds to rebuild the interior and had to abandon her property. The unfortunate part of this story is the association could have purchased an interior coverage endorsement for $943.00 a year, or $6.29 a year for each unit.

How does an association help its homeowners acquire the right insurance and, and for that matter, why should it even bother? After all, owners received a copy of the association CC&Rs and should have figured out themselves what insurance they want to buy.

Let’s go back not too many years ago and think about the purchase of the association master policy. A call would have been placed by the association manager to a (hopefully) good agent or one of the board members would have a recommendation or one of many other possibilities. That broker or agent would have acquired a copy of the existing insurance and a copy of the CC&Rs and tried to figure out a policy that was cheaper than the existing policy, probably by manipulating some of the coverages to make them fit his agenda. Everyone has a $1000 dollar deductible and the new policy, in the vast majority of the cases, covered all the buildings and their interiors.

The insurance companies soon found out it was costing more to replace the interiors of the units than it was to rebuild or replace the buildings. So in their wisdom, and a stroke of the pen, the coverages were soon adapted by the major carriers “to follow the legal documents,” and we all know how concise and unambiguous the legal documents are. Depending on how your CC&Rs were originally drawn now had a major bearing on how the association was insured and if the interior was covered. Did rebuilding the interior now become the responsibility of the homeowner merely by default? This often happened on renewal, and many association boards and managers, much less the individual homeowners, were not even aware of the new circumstances

Thus what should an association or board of directors do to assist a homeowner in acquiring the right coverage? Probably the most important thing an association board of directors can do is to review its association master policy with their broker and determine exactly how the interior is covered, if at all. If the board finds there is no coverage is in place for the interior of the units, commonly known as a “studs out” policy, the board may decide not to put the interior coverage in place or their existing insurer simply may not write that coverage or cannot endorse their policy for the coverage. In that case a contractor needs to be called (preferably one associated with ECHO) to determine what costs would be, on the average, to replace the interiors of the units from the unfinished interior walls inward.

Once this amount has been established, each homeowner needs to be informed of that amount and advised that they are responsible for the interior of their unit. Also each new purchaser should be given, as part of the initial disclosures, instructions that they are responsible for the interior of their unit and the average amount of insurance needed to protect their interest.

The obvious problem with each homeowner’s purchasing his or her own individual coverage for the interior of his or her unit is the lack of continuity of coverage from unit to unit. This brings up the question of the association’s retaining an equitable position for all homeowners. Not only will you have a variance in coverage, but also a variance in the insurance companies and the different method of payments, as well as endorsements that each company will bring to the table when it is time to repair a loss.

How would this affect the association? Two units owners sharing a common wall will be approached differently by their respective companies when a loss occurs affecting both units. Each company will bring its own set of priorities when approaching it’s homeowner’s interior repairs or replacement.

Boards of directors need to keep in mind that the equity of one unit affects all the units. The reason for this is simple. The sales price of one unit will affect the sales price of future units because the earlier sold unit will be considered a comparable to all the other units sold in the future.

A Solution To The Interior Coverage Dilemma

All association boards of directors should contact their insurance brokers or agents and set a meeting date so they can be fully informed about all of the master policy coverages, paying particular attention to how the policy addresses the interior coverage. Once the determination is made whether the interior of each unit is or is not covered, the board must reach a determination about how they want to address the issue. Each board should also reexamine the CC&Rs concerning the responsibility of the association and that of the unit owner.

The easiest solution to the problem would be simply to have your association’s policy endorsed to assure each unit is covered to its replacement value. This would maintain the continuity of the equitable position of the entire association. If you find that your current insurance carrier cannot assist you in doing this or just simply does not endorse their policies to include this coverage, it might benefit the association to entertain the possibilities of another company.

Purely economically speaking, if the average replacement cost of an interior of the average condominium is in the $50,000 to $75,000 range, the cost of the building coverage for each homeowner would be somewhere in the range of $200 to $500 a year. Depending on the number of units in the association, the endorsement to cover the interior of each unit for the entire association could be as low as $10.00 per year per unit. So we are talking of pure cost to each homeowner of about 5 percent to 20 percent of what they would have to pay if they purchased their interior unit coverage personally.

In the 154-unit loss mentioned earlier, the cost savings to the membership would have been a minimum of approximately $29,000 dollars. What association wouldn’t consider this coverage?

Monty Hollingsworth is a retired Farmers Insurance broker who now provides consultation services to associations and managers on association insurance matters.