The Complete Condo Package, Part 2

Piecing condominium association and unit-owner insurance programs together necessitate determination and complete information. A lot of pieces must be snapped together to assure a complete picture of protection. Any missing information leaves an unfinished picture and a gaping hole in either the association’s or unit owner’s coverage.

The first part of this two-part series (see Insurance Journal‘s Aug. 4 issue) provided definitions of real property peculiar to condominium associations, delineated associational versus unit-owner insurance responsibilities and discussed two federal flood policies as they relate to residential condominiums.

Part two of this report highlights how changes in Fannie Mae’s position may alter the future of condominium association responsibility, highlights property valuation based on responsibility and which valuation method is chosen and ends with a list of the information and documents necessary for any agent working with associations or unit owners.

Fannie Mae Changes

For decades the Federal National Mortgage Association (FNMA), Fannie Mae, has held sway over condominium association insurance requirements. Historically an association had to provide coverage under the single-entity (original specifications) guidelines to qualify to be part of a Fannie Mae package.

Announcement 07-18 released Nov. 15, 2007, changed these requirements. With this announcement, Fannie Mae relaxed its guidelines, now allowing associations to utilize bare walls insurance requirements when qualifying for the program in part as follows:

How this change is going to affect the future of state law and association declarations is not known. Many associations adopted original specification requirements solely to access Fannie Mae funding. Without this requirement, associations may be apt to return to the bare walls concept, the norm for many years prior to the Uniform Condominium Act of 1980.

Default Setting

Bylaws and declarations are the governing documents of all condominium or unit owner regimes. These documents supersede statute as per the statute itself. Division of ownership and insurable interest is dictated by these documents. Statutory wording is only the default setting if the bylaws or declarations are silent or are ambiguous on the insurance issue.

Valuing Association, Unit Owner’s Property

Statutes and even associational declarations differ on the valuation method required when placing insurance coverage on the association’s property. Actual cash value, replacement cost and even market value are mandated options in statute and association declarations.

Most statutes require actual cash value as recommended by the Uniform Common Interest Act. Ohio statute (5311.16) requires the association property be insured based on fair market value and other statutes mandate replacement cost.

Statutes are only the default setting. Insurance limits should be no less than the amount developed when the valuation method required by the declarations is applied to the property. However, replacement cost is recommended regardless of the amount required by statute or covenants, conditions and restrictions (CC&Rs).

Defined Values. Three distinctly different property values can be assigned to associational property: actual cash value, replacement cost and market value. Two are common to insurance, and one generally has no relevance in insurance, until the government or an unknowing attorney gets involved.

Actual cash value (ACV) is the cost new (replacement cost) on the date of the loss minus physical depreciation. Physical depreciation results from use and ultimate wear and tear, meaning that the insured does not get paid for the used up value of the property.

Attention must be paid to the beginning point in the calculation of ACV, the cost new on the date of the loss. ACV is not based on the value when it was built or at any point between the construction date and the date of the loss. Only the cost new on the date of the loss matters; this is key when choosing limits.

Replacement cost (RC) is the cost to replace with new material of like kind and quality on the date of the loss. There is no allowance or penalty for age, depreciation or condition. The insured must simply insure the property at what it will cost to buy or build it today.

Market value is negotiated between and agreed to by a willing buyer and a willing seller. It can fluctuate up and down based on the economy, condition, use or need and has little relation to the true cost to rebuild a particular structure. Normally, market value has little relationship to insurance. The rise and fall of the market value does not necessarily change the cost to rebuild a building following a loss.

Since this discussion revolves around the housing market, in a sense, let’s look at the decline of real estate values over the last several months. Census department statistics show that the average value of a home fell 11.2 percent from March 2007 to March 2008; and the National Association of Realtors reported that 2007 saw a 7.68 percent decrease in housing prices. Does this mean that the cost to rebuild a particular house or structure has changed? No! It simply means the person could not sell it for as much as they could a year ago. However, it would still cost the same or even more to rebuild the same house or condominium if it burned down.

If the market value is the rule applied in a particular state or association’s declarations, the agent must be prepared for and be able to explain this concept regardless of the fact that such value is not normally associated with property insurance values.

Values and Coverage: The Unit-Owners Form (HO 00 06)

Unendorsed, the Unit-Owners Form provides replacement cost coverage on the building (coverage “A”) and actual cash value on personal property (coverage “C”). Coverage “A” is limited to $1,000 unless increased by the unit owner. The owner’s need to increase coverage “A” is a function of the coverage required to be provided by the association based on the associational responsibility classification.

Both coverage “A” and coverage “C” apply broad form named perils coverage unless endorsed to cover “special” causes of loss. Expansion to “open perils” coverage can be accomplished by attaching HO 17 31 to coverage “C” and the HO 17 32 to coverage “A.”

Coverage “C” can be transformed from actual cash value to replacement cost with the attachment of the HO 04 90 – personal property replacement cost loss settlement endorsement.

Property Insurance Values. Establishing associational and unit owner values requires two pieces of information: who is responsible for insuring which property (see Part One of
this article in the Aug. 4 issue); and which valuation method (AVC, RC, or market value) is being applied.

Cost estimators are effective tools for developing accurate values in most replacement cost and actual cash value settlement scenarios, as are discussions with knowledgeable builders. If market value is the method of valuation, a market analysis by a licensed realtor may be required to develop the necessary value (it is not recommended that market value ever be used as the insurance value). The accuracy of these calculations varies based on the associational responsibility classification.

Original Specifications. Developing relevant values may be easiest when single entity requirements apply as the valuation program and original specification requirements overlap in their result and mandate. Property valuation programs calculate the cost of rebuilding the structure utilizing modern materials of like kind and quality; original specification insurance requirements limit associational responsibility to the cost of replacing original construction materials with modern materials of like kind and quality.

All-In. All inclusive statutes and association bylaws increase an association’s standard of care. Associations subject to this insurance settlement mandate are forced to closely monitor building and unit values (including value increases created solely by a unit owner) to avoid inadequate insurance and a possible coinsurance penalty since they are insuring all real property regardless of location or who installed it. Cost estimators work well in these associations provided the association and the agent are aware of any individual unit owner upgrades.

Bare Walls. Conflict arises if the unit owner does not have coverage, or enough coverage, to rebuild what is defined as the unit. The association is only responsible for the common elements and limited common elements. To arrive at the insurance value, a cost estimator has to be completed and the value of each “unit” must somehow be subtracted out of the calculation.

Two questions arise regarding the value of property in a bare walls association:

Attorneys, appraisers, agents and other professionals may be required to answer these questions and design the correct programs (one for the association and a separated one for each unit owner). A lot of professional expertise is required up front to avoid future disputes and the valuation answer is still just a little better than a guess.

Completing the Picture

Agents for both the association and the unit owner require the same mass of information to complete the condominium puzzle. All the pieces must be available. Agents must have:

• A copy of the association’s declarations or covenants, conditions and restrictions;
• A copy of the applicable state statute;
• An official letter documenting the definition of a unit’s boundaries detailing who is responsible for insuring which property. Many agents forego this step, depending on their own experience and knowledge to make this determination. This decision could prove detrimental in court; and
• A verifiable or signed property valuation calculation. Due to the intricacies of ownership and various combinations of responsibility to which condominium associations and unit owners are subject, getting a written valuation from a specially trained professional or approval from the insured will be beneficial should any questions arise. When insuring personal property only, let the insured value his property.

Insuring individual unit owners requires gathering and piecing together the same detail as does insuring a condominium association. Association and unit owner programs must dovetail seamlessly; unless both sides utilizing the same data, such a clean connection and complete picture is impossible.