Real Property Insurance Part II of III

By Dan Harkey

Parts I, II & III are found on www.danharkey.com

Insurance relating to insuring real property:

Real property ownership usually requires insurance and, in most cases, multiple coverages, mainly when a lender finances the property. Part I was a general overview of insurance, and parts II and III were overviews of real estate-related insurance and lenders' requirements.

Understanding the technical terms used in insurance, such as coverages, exclusions, endorsements, and adequate amounts. The insurance industry has specialized jargon; mastering it over time will empower you with the knowledge needed to make informed decisions about your real property insurance.

Types of coverage will be summarized at the end of part III.

Determining the correct amount of insurance is about meeting the lender's requirements and taking responsibility for the potential risks. It's a proactive step in protecting your real property.

There are different definitions of value. Market Value refers to the value of the property bought and sold in a competitive marketplace. This value is essential as it can influence the cost of your insurance. The legal definition of “market value” is a price at which the seller is willing but not compelled to sell and would accept from a buyer willing but not compelled to buy. Establishing an opinion of value, known in the industry as market value, is measured by comparing the market prices of comparable properties in neighborhoods with similar amenities.

Insurable value, which reflects the replacement cost of the buildings and appurtenant structures, is critical in real property insurance. This value is what your insurance policy will cover in the event of a loss, and understanding and accurately determining this value will give you a sense of security, knowing your property is protected against potential risks.

The appraiser plays a crucial role in determining the insurable value. Their job is to segregate the improvements from the value of the land property and determine replacement costs, including outbuildings and appurtenances. The appraiser’s appraisal report is used to determine the amount of insurance, and they will apply a depreciation factor and perhaps an economic obsolesce factor to create an overall value, providing you with a reliable and accurate assessment.

The land value component varies significantly with geographic location and desirability. A structure with an ocean, lake, mountain, city, park, or amenity-based frontage may result in a high premium for the land component. The property is assumed to be pleasant, attractive, and agreeable, which results in greater demand. However, the structure replacement cost may be the same regardless of land value.

If the loan is greater than the replacement cost of the building, the land is most likely more significant as an allocated portion of the overall value. A borrower should discuss the amount and types of insurance with their agent/broker to determine what is correct and acceptable to the lender.

Although liability insurance is not required, a borrower should have coverage for at least one million dollars. Five million is preferred because the premium is not much more. In the U.S., litigation, jealousy, envy, and hatred have become recreational activities. Liability coverage is essential in insuring residential rentals and commercial structures, such as a rental or leased fee retail. If the property is a residential structure, the liability portion of the coverage is an insurance rider referred to as an umbrella policy.

Additional insurance coverage may be necessary depending on the property's type and usage. These coverages could be included in the primary insurance policy or may require a special endorsement, adding to the complexity of insurance decisions. However, being cautious and prepared for all possibilities will give you a sense of security and peace of mind, knowing you are adequately covered.

A few questions to be answered:

·????? Understanding who the primary insured parties are is crucial in insurance. Similarly, including secondary or additional insured parties in the policy is a responsible step to avoid misunderstandings. This understanding will make you feel informed and accountable in your insurance decisions.

·????? Are there secondary or additional insured parties?

·????? Are there insurance considerations, such as insurance that property owners require of tenants or lessees covering various losses and liabilities that are not or should not be the property owner's responsibility?

·????? Are additional types of insurance required to cover furniture, fixtures, and equipment, loss of rent, business interruption, employee theft, loss of intellectual property, use of an employee or vendor vehicle not belonging to the insured party, workers' compensation, and liability?

Replacement cost coverage (RCV):

RCV is the amount required to replace the damaged or destroyed property with the same or similar substitute quality as was originally built.? Insurance for betterments and enhancements, building codes, and current zoning ordinances will require a different form of insurance or endorsement to bring the property up to today’s standards. ?The definition of insurance replacement cost does not include this form of insurance.? An additional endorsement to the policy usually provides this form of insurance.

The insurance definition of replacement cost is hypothetical and not a reality because “the same and substitute the quality of materials” is so radically different over an extended time that it is probably not economically feasible.? Replacement cost insurance may be ambiguous to public purchasing insurance policies as a protection mechanism.

Replacement cost verbiage in the insurance policy needs to reflect current codes, ordinances, regulations, designs, and available materials.? A property built in 1946 contemplates reconstructing the building to those same 1946 standards.? Older properties may be characterized by obsolete materials such as asbestos, lead-based paint, and galvanized metal piping in the plumbing.? An example of upgrades not covered would be replacing 1946 installed single-pane windows with aluminum frames with modern double insulated low-E glass panes with vinyl frames, upgraded anodized aluminum frames, or wood frames.

Structural designs, engineering requirements, building materials, and add-on standards have changed dramatically over the last 50 years and accelerated during the previous 20 years.? Most of these new requirements are government-driven mandates where current insurance products may not work correctly or are inadequate.? Insurance carriers may not be willing to write policies to cover unknown risks.

The requirement of the insured party to invest additional capital in upgrading or bringing the property into current compliance with raising rents and enhancing value is not part of a standard insurance policy.?

Interested parties may visit www.insurance.ca.gov ? for an overview of insurance products and definitions.

Extended replacement cost coverage:

The coverage protects the insured against sudden increases in materials or construction costs.? This type of insurance is additional; however, it is more extensive and expensive protection.? Some carriers will offer extended replacement options as an endorsement that may cover a further rise of 20% to 25% of the replacement cost up to the policy limits.? However, 20% or 25% may not be enough to pay for higher prices and new government-mandated upgrades.

Actual cash value policies (ACV):

Actual cash value coverage may be an insured party’s choice to save money on the premiums.? A loss is calculated to include the depreciated fair market value of the damaged or destroyed dwelling at a loss and up to the policy limits.? In other words, replacement cost minus depreciation of the damaged property (ACV=replacement cost less depreciation).? It represents the dollar amount you expect to receive by selling the property on the open market.? This form of insurance may serve as a red flag and significantly alter the underwriting by a lender.?

This form of coverage is more common for older commercial and industrial properties.? An (ACV) policy is a bad idea in almost all cases.?

Zoning and building ordinance Insurance:

Improvements and betterment insurance Coverage may be purchased separately by endorsement.? Coverage to pay for upgrades or updates to meet current building codes is available.? Examples may include weather, fire safety, wiring, or handicap accessibility.? These coverages vary in what is covered and what different insurers exclude.

Policy exclusions:

Carriers have different exclusions and what they will cover by separate policies and add-on endorsements.? Most insurance carriers have policy exclusions including but not limited to ordinance or law, tsunamis, floods, drain & and sewer backups, seeping groundwater, standing water, mold, total pollution exclusion, asbestos, lead-based paint, earthquake, earth movement, acts of war, mold/mildew & fungus, acts of war, nuclear, biological, chemical, acts of terrorism, etc.

Insurance does not cover damage due to poor maintenance or quality, general wear and tear, pest infestations, power failure, nuclear hazards, government actions, intentional loss by the insured, and home-based business liability unless specific endorsements are purchased. ??

Coinsurance provisions:

Many insurance policies for both residential and commercial have language referred to as covering the coinsurance provision issue of under-insurance.? A coinsurance clause requires that policyholders insure their property for a reasonable replacement cost.? The insurer will receive a fair premium for the risks.? A coinsurance clause will require that policyholders insure up to 80, 90, or 100% replacement cost for the structure(s) and appurtenant(s).

Coinsurance penalties will be applied to claims for underinsurance and will differ according to companies and policy types. Effectively, a coinsurance penalty triggers a contractual requirement that the insured party pay a portion or penalty of their financial loss using a calculation formula in the policy. Some insurance companies provide step-up coverage endorsements to reflect higher replacement costs due to inflation.

If a policy contains a coinsurance penalty provision, a claim may result in an underinsured claim.? The insurance company will pay up to the policy limits and leave the underinsured party responsible for the remainder.? The insured party may be required to pay for a portion of their loss.? Their portion is part of the cost of reconstruction, including betterments and enhancements.

Under-insurance is more prevalent now than before because of the upward cost pressure caused by inflationary increases in construction costs. For example, lumber prices, other materials, and labor have increased dramatically. Municipal approvals and building standards/codes are much more stringent. Add-on municipal fees (taxes) have gone up.

A mortgage broker/borrower or insurance provider who calculated $200 per square foot a few years ago may find that the replacement cost has doubled to $400 per square foot, not counting the land value.? Housing replacement costs may range from $200 per square foot for entry-level production homes to $1,000 to $2,000 for high-end customs.

Lenders and mortgage companies may want to audit their loan portfolios to ensure that property coverage adequately offsets inflation. They may also discuss methods and data sources for calculating replacement costs. Most insurers and appraisers use Marshall & Swift cost estimator data to estimate the construction cost.

Forced order insurance coverage:

If borrowers fail to pay their premiums promptly or default, the loan servicer will demand the borrower to pay the current premium.

Example notice mailed to the borrower:

Loan Number:

Property:

Property Address

Amount of coverage:

Amount of premium:

Dear Borrower:

Since you have yet to provide the required proof of insurance, the loan servicer purchased insurance on your behalf on the above-referenced loan under the terms provided in your loan documents.

The policy cost must be paid in full with interest accrued and your regular payment.? BE ADVISED that this interim policy will only be suitable for 60 days.

To avoid further default on your loan, you must replace this temporary insurance with a permanent policy within the 60-day time frame above.? Failure to do so may result in foreclosure proceedings being started, and a Forced Order Policy will be purchased to protect the beneficiary's interest at a considerably higher cost than the policy you can buy.

BE ADVISED THAT THIS POLICY COVERS THE REAL PROPERTY ONLY; IT DOES NOT PROVIDE YOU WITH LIABILITY COVERAGE, THEFT, OR ANY COVERAGE RELATING TO YOUR HOUSEHOLD ITEMS OR ANY PERSONAL PROPERTY.

If you have any questions regarding this notice, contact us immediately upon receipt of this communication.? Time is of the essence.

Sincerely,

Loan Servicer

Forced order insurance is called “forced-placed” or “lender-placed” insurance.

Federal Law Restricts Force-Placed Insurance.

Before purchasing a force-placed insurance policy, the servicer must reasonably believe that the borrower has failed to maintain home insurance coverage. Verification is usually done by calling the insurance carrier or broker.

Suppose the borrower's insurance agent or insurance company contacts the servicer to inform it that the bill is overdue. The servicer will have a reasonable to send notice to the borrower.

The servicer must send two notices to the borrower before placing force-placed insurance. The notices must request that:

· The borrower obtains hazard insurance for the property and

·???? submit proof of insurance to the servicer, such as a copy of the insurance policy declaration page, an insurance certificate, or the policy.

Timing of the Required Notices:

The servicer must send the first notice at least 45 days before placing a force-placed insurance policy. The servicer must send a second reminder notice no earlier than 30 days after the first notice and at least 15 days before charging the borrower for force-placed insurance coverage. This notice must include the cost of the force-placed insurance or a reasonable estimate. (12 C.F.R. § 1024.37).

The Servicer will generally advance funds to the existing policy to keep insurance placed on the property. The servicer can cancel the coverage and place a forced order if desired. If the property is vacant- (12 C.F.R. § 1024.17) applies.

When the borrower provides proof of Insurance coverage, the servicer will:

·???? cancel the force-placed insurance within 15 days of receiving evidence of existing insurance.

·???? refund any premiums necessary to avoid duplicate coverage- (12 C.F.R. § 1024.37).

Parts I, II & III are found on www.danharkey.com

Thank You

Dan Harkey

Educator & Private Money Finance Consultant

c 949 533-8315 e? [email protected] , visit danharkey.com

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