Insurance Myths For the Real Estate Investor

Insurance is the one thing for which we pay that we never want to use. However, in the event you need it, you certainly want to be properly protected. The points presented here should hopefully allow you to grasp a few of the pertinent insurance issues for whatever your real estate endeavor may be.

Myths (presented in no particular order):

1. Insurance is mutually exclusive of estate, tax, and financial planning…

Actually, insurance inter-relates to each of these, as they should work in harmony with one another. You attorney, accountant, financial planner, AND insurance advisor should certainly know what each of the other has planned specific to your goals. As such, excluding one from the others is contradictory to efficiency and cost-effectiveness. Consider these four folks as your “trusted team of advisors” and encourage them to consult one another as necessary.

2. Being named as an “additional insured” on the existing homeowner policy will protect my interests in a subject-to deal…

This could do much more harm than good, in reality, if you (or your entity) own, or have a financial “stake” in the property, be the “first named insured”. The first named insured is the primary recipient of any potential claim benefit or liability protection. An “additional insured” will garner liability protection only. A “loss payee” will have its interests protected in the event the property itself is damaged. (A mortgagee is inherently BOTH). If you decide to keep the “homeowner’s” policy in place and be named as the additional insured, be advised. If it is discovered that the ex-owner, the first-named insured in this case, no longer owns the property, expect the insurer to deny based upon the fact the policyholder no longer owns the property. Even if you manage the claim to be paid, you are not the entity to receive the proceeds, as you are not the first-named insured. If you did attempt to be added as a loss payee as well, chances are the insurer will question the necessity for you being named as such. When the insurer discovers you now own the property, they will need to write a new policy.

3. Buying a property in your personal name and using your homeowner’s policy liability is fine…

I can’t think of any reason that exposing your personal assets to the risk of real estate investing makes sense. If this is the only option your current insurance person suggested, then either find one that is more real estate investing-savvy, or take the time to help them understand more about what you do. The last I want to do is tie-in “my stuff” to the exposures of my real estate investments. Asset protection strategization inherently is a combination of insurance, entity creation, and “compartmentalization”.

4. The “personal” dwelling fire policy is sufficient (“cheap”) to cover my non-owner occupied rental…

Those that usually promulgate this attitude in the insurance industry either don’t have commercial-type carriers/markets and/or proper knowledge. Not only does the dwelling fire policy require liability to be extended from your homeowner’s policy (see #3), many coverages that are vital to a true “rental” property are either missing or need to be purchased over and above. Though the basis of a completely different presentation, some of the highlights of the “commercial policy preference” are the inclusion of rental loss coverage, unit limitations, and pollution exclusion issues.

5. I have a personal umbrella policy (PUL), so I don’t need commercial insurance…

Like most insurance polices, your personal umbrella protection contains much exclusion. One of the most glaring for the real estate investor is the “business pursuit” exclusion. If your real estate investment(s) aren’t a “business pursuit”, then you need to consider divesting! In other words, your PUL is designed for “personal” exposures. A commercial umbrella over and above the liability in your commercial package policy is appropriate.

6. A claim that occurred before I (or my entity) owned the property shouldn’t affect MY insurance rate…

The insurance industry not only underwrites “you”, they also underwrite and rate based upon the claims history of the property itself. A CLUE (Comprehensive Loss Underwriting Exchange) report will detail the claims that have occurred at a certain address (as well as other criteria). Have your insurance advisor run a CLUE on your next property BEFORE you make an offer. The insurance rate can certainly affect your ROI…

7. “All-risk” insurance covers everything I need…

By definition, “all-risk” simply means that unless something is excluded, it is covered. “Named peril,” means just that, in order for a loss to be covered, it’s cause must be named in the policy. So, even though “all-risk” is a more comprehensive form, it does not mean that “everything” is covered. Take a look at your policy exclusions. Not that many of these exclusions can’t be purchased back, but they usually generate a pretty long list.

8. Self-insurance is too risky…

A deductible is technically self-insurance. As a rule-of-thumb, consider the lowest claim amount you would file with the insurance carrier, then double it. This is the minimum deductible I would suggest you carry. There is a point of diminishing return, however. In other words, though you may not file a $5,000 claim, if the premium savings it (versus, for instance, a $2500 deductible) is negligible, then you may as well go with the lower. In the long run, statistically, the premium savings by carrying “higher than usual” deductibles usually pay for themselves. Remember also, that completely self-insuring a known amount, such as a property with an arguable repair or reconstruction value, can be a consideration. However, self-insuring unknown amounts, such as liability claims, may not be the best idea.

9. I need “builders risk” coverage for a vacant or rehab project/deal/property…

Unless the rehab is “considerable” (definition varies by insurer), there are policies specifically designed for the rehab property. In our area, Diamond States, AMIG (American Modern), and Foremost all offer such contracts. If an insurance agent advises that they cannot find coverage for your rehab property and offers the Ohio Fair Plan, chances are they simply don’t have they contracts with the carriers mentioned. The Ohio Fair Plan should be the last option for the property, not the first.

10. It is worth it to hire the “handyman” to do work on my rentals…

Don’t get caught up in the great bid to do work in/on your rental property or rehab project from the “fly-by-night” handyman-type help. Chances are, they not only do not carry liability insurance (puts the risk back on you as the owner), they also probably don’t carry worker’s compensation (WC) protection. It isn’t worth the risk to save a few bucks to not hire the “legitimate” contractor for such endeavors. Even the tenant who cuts the grass for reduced rent potentially exposes you to WC and liability issues. Always require contractors to provide certificates of insurance (COIs) for both their liability and WC coverages.

11. (Bonus) Cheaper is better…

The cliché rings true: you get that for which you pay. Work with an insurance advisor that understands the idiosyncrasies of real estate investing. They can be an independent or a “captive” agent. As long as they have a recognition of the challenges that face your investing endeavors, and have access to a carrier (or carriers) that fill your needs (in conjunction with the strategies discussed here), challenge them to get you the best VALUE for your insurance, not the cheapest rate.

Insurance is a gamble. The insurer is betting you won’t need it, while you bet that you will. With the help of a professional insurance advisor, gain enough knowledge to make cognizant decisions on your specific needs. As part of an asset protection plan, it is vital that you are comfortable with your coverage and protection BEFORE you need it. I sincerely hope all of your premium dollars go to waste!