An investor just blew $45,000. Want to know why?
Attorney · Raleigh, NC · Member since 2008 · 4k+ posts · 1k+ votes
An investor who had a fire at their property had full insurance coverage on the loss, the policy was in force, had about $90,000.00 in damage, had a limit of insurance of 1.5 million dollars, and was a clear cut case of a covered loss that should have had a full payout less the 5k deductible. However, the investor blew $45,000.00 of the insurance payout by doing one thing wrong. Care to know what that is?
Maybe it wasn't fair since I was an insurance agent in P&C, and as Tim points out, it's the replacement value.
About the only thing you can do is to review your policies annually. I insure to 90% of the replacement value, as long as you are over 80%, the clause does not kick in and losses are paid at 100% on my policies. The other thing is to send a letter to you company and insurance agent, registered, return receipt requested and keep the receipt. This letter instructs the company and agent to notify you of any change in valuation of the insured property, since only they will know if the MS analysis changes at any time. If it does change and they fail to modify your policy to reflect the proper amount, it's on them!
You agent then has a responsibility to keep your policy current to its replacement value.
I'll bite...why?
OK Tim, was it the co-insurance clause, he didn't have more than 80% of the value insured so he could only collect to the extent he had it insured to the value of the property? Let us know, there are other screw ups too, but that's my first guess.
"was it the co-insurance clause"
There was a problem there.
"he didn't have more than 80% of the value insured so he could only collect to the extent he had it insured to the value of the property?"
Very close. He had it insured to 100% of "a" value. It's a common mistake for investors to make.
(Not really fair to everyone else here because Bill and I have discussed Marshall Swift before...lol For us, a lot of this is insider baseball.)
Who gets to determine "true value" in these cases? Appraisals are always squishy so is the co-insurance based on the insurance company's opinion of replacement value?
So how is replacement value determined? It seems you would have to OVER insure the property if the co-insurance clause was frothy…around 90% or so because the insurance company could play with the numbers when the claim is filed.
Here's the error.
When you insure a large multi unit property, you often have a coinsurance agreement where you are required to give a value of the property that is 80-100% accurate in the REPLACEMENT value of the property. This can be a problem with investors who are used to buying property at deep discounts in order to increase their cashflow and insure the property for "how much they have into it." It doesn't matter how much money you have into a property when you have a coinsurance agreement in your policy. What matters is how much it would cost in real dollars to physically replace that property.
Let me give you a real world example. I have 2 buildings in Chicago, both 100 units, both the same size, both the same construction style and age and quality. One will have a market valued of 4.5 million based on it's location, the other will have a market value of 1.5 million. That doesn't matter if you have a coinsurance agreement. If you have a coinsurance agreement, what is going to matter is that each property is worth 3 million dollars in Replacement value (i.e., the actual cost to rebuild on a fresh lot new). This isn't a problem for the guy who insured his property for 4.5 million (he may be overinsured). This is a BIG problem for the guy who had his property insured for 1.5 million and has a coinsurance agreement.
In this case, this is exactly what this investor did and has a coinsurance agreement not of 80%, but of 100%. That means he needed to carry insurance of at least 100% of the building's replacement value or he would only be paid out the percentage of the claim that represent the percentage of the building's replacement cost he insured.
In this case, he was half insured.....so it's going to penalize him half his insurance payout. It sucks finding this out on the back end. If you're going to get this kind of insurance, get a real replacement valuation on it. Don't rely on the appraisal you got at closing or the tax assessor's value.
Ok, I'm a little confused here guys. When you say -
"Very close. He had it insured to 100% of "a" value. It's a common mistake for investors to make."
What do you mean by that?
Maybe it wasn't fair since I was an insurance agent in P&C, and as Tim points out, it's the replacement value.
About the only thing you can do is to review your policies annually. I insure to 90% of the replacement value, as long as you are over 80%, the clause does not kick in and losses are paid at 100% on my policies. The other thing is to send a letter to you company and insurance agent, registered, return receipt requested and keep the receipt. This letter instructs the company and agent to notify you of any change in valuation of the insured property, since only they will know if the MS analysis changes at any time. If it does change and they fail to modify your policy to reflect the proper amount, it's on them!
You agent then has a responsibility to keep your policy current to its replacement value.
Never mind. Apparently Tim answered my question while I was typing up my question.
I did a Google search and found this:
APPRAISAL - If you and we fail to agree on the amount of loss, either one can demand that the amount of the loss be set by appraisal. If either makes a written demand for appraisal, each shall select a competent, independent appraiser. Each shall notify the other of the appraiser's identity within 20 days of receipt of the written demand. The two appraisers shall then select a competent, impartial umpire. If the two appraisers are unable to agree upon an umpire within 15 days, you or we can ask a judge of a court of record in the state where the residence premises is located to select an umpire. The appraisers shall then set the amount of the loss. If the appraisers fail to agree within a reasonable time, they shall submit their differences to the umpire. Written agreement signed by any two of these three shall set the amount of the loss.
Apparently that is the language that is standard in most policies. So I guess that is a check on the insurance company going nuts with arbitrarily setting replacement values to benefit them.
We bought an apartment complex in ’08 and had the very problem you are talking about Tim. Luckily our agent is scrupulous and told us to insure the property for much more than the purchase price…which was well under market value.
BTW...GREAT advice Bill!
Jesse, a repalcement insurance policy is based on a replacement value of the property insured, not the market value. You can buy a property for 100K, but it might require 140K to replace it, stone for stone. The replacement value is determined by an analysis by Marshall Swift, supposedly an appraisal organization, but who really is in the pocket of the insurance industry, IMO.
Your policy will require you to keep your property insured to at least 80% of that replacement value and if you do not, it is then assumed that you have elected to be self insured on a per centage basis as to what you have insured the property at, so if you have insured at 50% of the replacement value, it is assumed under the 80% co-insurance clause of your policy) that you are responsible for the other 50% of the dollar amount of any loss.
Got it Bill, Thanks.
It's a type of policy that I've never seen or been presented with in the past. Thanks for spelling it out for us young guns who haven;t dealt with it before.
Welcome Jesse,
Just to clarify, the appraisal process Bryan pointed out is for the assessment or appraisal of the loss, the value of the damage, not the replacement value that needs to be insured. This is apples and oranges. If I should have had the property insured at 100K, and have a loss, we can disagree on the dollar value of the loss and go through an appraisal process to determine that it is a 10K loss. If I only carried 80K of insurance then the company is only obligated to pay 8K on my loss.
If I had insured the property at 90K, over 80% of the required amount to be carried, many policies will then pay 100% of the loss, as it generally kicks in at 80%, thus known as the 80% co-insurance clause.
"About the only thing you can do is to review your policies annually. I insure to 90% of the replacement value, as long as you are over 80%, the clause does not kick in and losses are paid at 100% on my policies."
This is true with policies with an 80% coinsurance agreement. However, some folks have them with 100% coinsurance agreements. Those 100% ones don't have the 20% cushion.
"The other thing is to send a letter to you company and insurance agent, registered, return receipt requested and keep the receipt. This letter instructs the company and agent to notify you of any change in valuation of the insured property, since only they will know if the MS analysis changes at any time. If it does change and they fail to modify your policy to reflect the proper amount, it's on them!"
This won't change the policy. The coinsurance agreement of an insurance policy puts the burden of responsibility on the insured to have their insurance properly set to the valuation of their building.
"You agent then has a responsibility to keep your policy current to its replacement value."
No, in the end the proper application of coinsurance is your responsibility, with one exception -- and it's going to cost you. You can get a policy with "Agreed Value" instead of coinsurance. "Agreed Value" usually costs extra and cancels out the requirements of coinsurance, but still makes you subject to the total limit of insurance.
A lot of this above stuff you typically don't run into with SFR policies. This is for multi-unit commercial stuff and if you get into one, you would behoove yourself to take the time to do this right. It's a costly mistake. $45,000 is just the most recent example. Last year I had a guy under insure by about 40% on a claim that came out to just over $880,000.00. 40% of $880,000.00 is not an easy amount to come up with out of pocket.
Right Tim, did not mean to say any letter changes the terms of the policy, it does not. What I said was, notify me if the repalcement value )Marshall Swift) for my area changes, it is not the insureds responsibility to know what the comapny's base line is. What I was saying is that if the valuation changes, notify me and add it to my policy or keep me fully insured or at what ever level. This is not an obligation on any insurance company, but it is on an agent.
If I had a client and I failed to properly insure a building, at the written direction of my client and he had a loss, he has a basis to seek indemnification from me! Any good company will stand behind a GOOD agent, been there, done that.
And yes, not all policies have 80%, I kept myself from writing a couple paragraphs by saying generally, but just trying to expalin the 80% and the co-insurance basis.
As an independent adjuster, I'm sure Tim has seen a wider variation of policies than I have, not all policies are the same. And, the Agreed value is a good route to go, but is not available everywhere, I would do that, but can't find them here.
As I mentioned, my issues is not having a total loss from fire, it's tornado and hail damage and usually that is not a total loss. And, if I did have a total loss, I doubt I would build anything back as it was, I would probably build something close, but not the same....if ya know what I mean.
So it does say that…So how the heck do I determine what the insurance company thinks my replacement value is each year? I can monitor market rates and assessed values, but I can’t market replacement values easily…can I?
I guess that is possibly why an 80% co-insurance policy is “standardâ€â€¦.I guess we can get things that close fairly easily.
Properties would seem to be underinsured over time as they appreciate without adjustments to the policy and thus the 80% co-insurance clause would be more of an issue as time goes on without updates to policies.
"If I had a client and I failed to properly insure a building, at the written direction of my client and he had a loss, he has a basis to seek indemnification from me! "
That's probably why the policies I've adjusted on put that responsibility back on the insured. :lol:
"And, the Agreed value is a good route to go, but is not available everywhere, I would do that, but can't find them here."
Check on Granite State. They write in Illinois - not sure about Missouri.
"So it does say that…So how the heck do I determine what the insurance company thinks my replacement value is each year? I can monitor market rates and assessed values, but I can’t market replacement values easily…can I?"
Post the square footage of your building, it's exterior wall covering, it's roof type (comp shingles, etc...), the height of each floor, and the number of floors and I can run a quick valuation for you with a HUGE caveat that neither I nor BP, nor Josh nor the asian sweat shop of highly trained squid Josh is using to code for this site is liable for providing you an accurate figure. This is strictly an exercise.
"I guess that is possibly why an 80% co-insurance policy is “standardâ€â€¦.I guess we can get things that close fairly easily."
It provides much better wiggle room.
"Properties would seem to be underinsured over time as they appreciate without adjustments to the policy and thus the 80% co-insurance clause would be more of an issue as time goes on without updates to policies."
This is true even though the valuation tends to tick upward slowly.
Well all of this seems pretty shady to me, but it doesn’t surprise me. Insurance companies will do just about anything to prevent people from collecting on claims I guess.
Without a method to know how much the insurance company values the replacement cost this whole co-insurance clause seems like a scam to me. I guess they want people to err on the side of over-insuring properties so that they can collect the delta as a nice little annuity on every policy annually.
Does it make good sense to HAVE to insure something for a higher amount if the owner wants to limit their indemnity amount in the event of catastrophic loss?
Thanks for the kind offer Tim. I already sent my guy at Farmers an email to see how to handle this based on our discussion on the thread.
Oh..and I like the highly trained sweatshop comment…good stuff!
"Well all of this seems pretty shady to me,"
Funny, that's usually what people say about my real estate investing rather than my day job.... :lol: Like many things it is just something that doesn't sound right until you understand it - then you understand how important it is. If everyone in a city had an under insured building and a disaster occurred, the owners of the buildings in the poorer neighborhoods would have more incentive to take the insurance check and run rather than actually rebuild.
Well shouldn’t that be their prerogative? They, after all, are the ones that own the building! Aren’t they really protecting their INVESTMENT and not the form of the building?
Consider this too, that debris removal is included in most policies as an additional benefit, over and above the indemnification of the loss, so taking the money, paying off the mortgage, having the mess cleared away and running, is an option!
I thought about that…what happens if there is a partial loss? So you are saying that the insurance company would cover that per the policy and presumably be out the money because the owner took the money, paid off the policy, and ran?
It seems to me that the insurance company is narrowly defining the rules to suit themselves the best with this co-insurance clause. It forces people to over-insure the property because there is no way to know what the insurer claims replacement cost will be! Of course…a 20% delta should be wide enough to get things right, but I still maintain that the owner should be able to pocket the money if they want to. Why should it be necessary for them to rebuild if that is not what is in their best interest at the time in their estimation?