While bonds are sold by licensed insurance brokers, but they aren’t actually insurance.

You see, with insurance, a person or business pays a premium to the insuring company which transfers most (if not all) of the risk from the customer purchasing the coverage to the insurance company. In the event of a claim or loss, the customer is only responsible for paying the deductible since the insuring company has assumed the customer’s risk.

Bonds are different.

The only similarity between insurance and bond, is  that they are both sold by insurance agents and both require the payment of a premium.

When a person or business pays for a bond, they (the principal) does not transfer risk to the “surety” (the company issuing the bond).  Instead the responsibility for the payment of claims will still fall on the principal (customer). You see, when dealing with bonds, the protection afforded from the purchase of the bonds goes to the person or entity that requires the principal to purchase the bond in the first place (referred to as the the “obligee”).

When dealing with losses under a normal insurance policy, it is the insurance company that is responsible for paying out claims.  For example, assume a customer has an auto insurance policy that cost $600 and has a $500 deductible for comprehensive coverage.  If that customer walked out in the morning to find that his or her car had been stolen, he or she would only be responsible for paying the $500 deductible listed in the policy; it is the insurance company that would be responsible for paying the remainder of the claim, even if it were $10,000 or $20,000 vehicle – which is far more than the policy itself cost.   The risk was transferred to the insurance company with the purchase of the policy and the customer’s exposure to loss is limited to just the $500 deductible.

However, bond (aka “surety”) companies do not expect to make such payments on claims, and instead treat the premiums paid for bonds as service charges.  In essence, the premiums just authorize the principal (customer) to use the bond company’s deep pockets for financial backing in the event of a loss (like a short-term loan), which is what provides the required ‘guarantee’.  If you have a claim that it paid out by the bonding company, the company will turn around and expect you to repay them in full per the bond agreement.  This is why a start-up company with few or no assets may not be able to obtain a $500,000 performance bond for a project.  Sureties view their underwriting and issuing of a bond as a line of credit, so their focus is on the pre-qualification of customer’s and the selection process.  Because of this focus, not everyone will be bonded.  The truth is, in today’s market it is getting more difficult to be bonded and if you fall into this situation because of poor credit, or you are a start-up company with no credit, it may be more difficult and/or expensive to get ‘ bonded’ using a non-standard market.

In summary, the insurance industry is built around statistics, actuarial data, the calculated likelihood of loss, and the assumption that customers will file claims and need to use their insurance.   In the bond industry, however, claims are not looked at as inevitable (like they are with insurance), but instead it is assumed that all parties involved will do everything in their power to avoid such losses and that the bond’s ‘guarantee’ will only be used as a last resort.

A Performance Bond vs. Professional Liability Insurance (E&O)

This may be a short article, but it’s an important one – especially with regards to insuring seller-financed ‘wraparound’ mortgages. Since the insurance industry is founded on the principals of risk, contract law, and civil liability, properly insuring properties purchased in this manner can be a challenge, especially when titled in a trust, and the issue of ‘legal‘ title versus ‘equitable‘ title often arises with regards to who has an ‘insurable interest‘ and who doesn’t.

EQUITABLE TITLE – This type of title refers to the actual enjoyment and use of a property without absolute ownership. It is the interest in the property held by a buyer (vendee) under a purchase contract, contract-for-deed, or an installment-purchase agreement. The buyer (vendee) has the right to demand that legal title be transferred upon payment of the full purchase price after the final installment payment has been made. This interest is transferable by deed, assignment, subcontract, or mortgage. Equitable title is conveyed to the buyer (vendee) as soon as the seller (vendor) actually countersigns and agrees to the offer to purchase. In other words, Jack agrees to purchase a home from David under a contract-for-deed’ arrangement. In layman’s terms, a contract-for-deed means “you (buyer) fulfill your part of the contract (pay the balance in full) and ONLY THEN do I (seller) have the obligation to transfer the deed to you.” Jack takes ‘equitable title’ in the property as soon as David agrees to the contract and signs it. However, the legal title (which defines absolute ownership) is not formally transferred from David (seller/vendor) to Jack (buyer/vendee) until he has made his last installment payment under the contract and paid the agreed-upon amount in full, whether he pays the balance in one year or over a period of thirty years. Also, with equitable title, the vendee (purchaser) benefits from any increase in value between the date of the agreement and the final delivery of the deed once the balance is paid in full. If the property increases in value the vendee gets the increased valuation of the property; if the property value declines the vendee in turns suffers that as well.

Equitable does not give the actual legal title to the property like it would if a buyer were using a mortgage. Equitable Title means giving the buyer an “equitable position” in the property. The legal title is conveyed only after the buyer has satisfied the contract.

The reason that equitable title and not legal title is conveyed in contract-for-deed purchases as mentioned above is because there is no deed of trust filed, this only occurs AFTER-THE-FACTonce the purchaser (vendee) fulfills the contract agreement, and legal title can only be transferred by a deed.

LEGAL TITLE – Legal title is the ownership of property that is enforceable in a court of law, or one that is complete and perfect in apparent right of ownership and possession, but that unlike equitable title, carries no ‘beneficial interest’ in the property. In other words, in the example of David and Jack above, David holds the ‘legal’ title to the property and is the ‘legal owner’ while Jack only has ‘equitable title’. However, with his ‘legal’ title, if the property goes up in value, David cannot benefit from this change and retroactively increase his sales price to Jack to make more money. As another example, if valuable minerals were discovered on the property, David could not ‘benefit’ from this change in the property either.

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When utilizing traditional mortgage financing involving a bank or institutional lender, there is promissory note, a mortgage, and a deed of trust signed and filed. This deed of trust is what transfers legal title from the seller to the buyer. The seller of the property transfers legal title to the new buyer at closing because the contract price has been paid in full by the bank or lender – and now it’s up to the borrower to repay the lender in installments. The buyer now has both legal and equitable title. In turn, the buyer collateralizes the bank’s loan with the property being purchased and the legal title still remains with the buyer unless there is a foreclosure. If a foreclosure occurs on the property, the deed (and legal title) is transferred to the lender so that the lender then retains legal title.

What Is An Insurance Score? How Is It Determined? How Does it Affect My Premium?

Your insurance score is a snapshot of your specific ‘insurance risk’ at a particular point in time – but it is important to know that it is not the same thing as your credit (FICO) score, although they are similar in nature. As a standard underwriting consideration, an ‘insurance score’ is a rating used by insurance companies to assist in determining insurance premiums and which is made up of several factors, just one of which is your FICO score (which is why you and all other members of the policy are often required to provide a social security number when requesting a new insurance quote). Other factors, depending upon the type of insurance, may include your driving record, past claims history, occupation, property data, and many more ‘data points’. Evaluating these factors together helps insurers determine if you qualify for their underwriting programs, and at what rate. Although there are a few common data points that all carriers are required by law to utilize in order to maintain a consistent basis of measurement, such as your FICO score and driving record for auto insurance, each insurance company still has its own proprietary formula for determining a customer or prospective customer’s insurance score depending upon the company’s own ‘appetite’, target market, and underwriting parameters. For example, a standard company such as Safeco Insurance may place a higher value or ‘weight’ on a person’s FICO score than on their driving record or claims history to determine premium while a company such as Progressive Insurance, which handles both standard and ‘non-standard’ drivers, may do just the opposite and place a higher weighted average on the driving record and past claims history than on the FICO score itself. In both scenarios the same data is used, but it is up to the individual company to decide how it is used as it relates to their desired customer base, insurance products, and appetite for risk.

While many people complain about the use of their credit scores when determining insurance rates, it is often because they either don’t understand the reasoning behind this scoring or they have simply have lower FICO scores themselves which leads to higher insurance rates. Regardless, the complaints are unfounded and moot as carriers still require the use of this information regardless of its popularity. The reason is simple. The insurance industry is founded and operated on statistical probabilities and actuarial data – not ‘gut feelings’ – and it is a well-proven fact that an individual’s FICO score has a direct correlation with the likelihood and severity of future claims. Generally speaking, the lower the FICO score, the higher the probability is that a claim, or multiple claims, will be filed.

‘Soft Hits’ and What Your Agent Actually Sees

Unfortunately, there are two very prevalent, but false, myths surrounding the use of credit-based insurance scores. The first myth is that your agent sees your credit report and the second is that shopping for insurance affects your credit (FICO) score because of the credit inquiries.

To begin with the first myth, your agent never sees your credit report at all and he or she has absolutely no idea whatsoever as to what is or isn’t contained in your credit file. From an agent’s perspective, all he or she ever sees is a numerical score, usually ranging from 01 to 31 (with 01 being the best at 31 being the worst) that appears on the quote itself. The agent has no idea what data points are being used to comprise this score or which ones are the most heavily weighted. The agent doesn’t even have the ability to research this data and it is completely confidential. In other words, the agent is ignorant of any of the facts and data behind the score and all he or she sees is the premium provided by the insurance company itself.

Regarding the second myth, the fact that insurance companies are pulling data from your credit report does not affect or lower your FICO score because of ‘excess inquiries’. When an insurance company requests your credit data, it is coded as an insurance-based inquiry which is treated as a ‘soft hit’ by the credit reporting bureaus. This means that it does not count against your credit score because the pre-existing data is being requested for the purpose of determining an insurance rating, not because you are actively seeking to obtain new credit – as in the case of applying for a new credit card or purchasing a new home or automobile. This inquiry is no different than if you were applying for a new job and your employer ordered a credit report to verify your financial history and indebtedness. It is a ‘non-issue’.

What Happens if You have No Insurance Score?

Finally, if you are searching for new insurance, there is a small likelihood that the insurance carrier may not be able to locate you in the credit reporting system and no insurance score can be determined. This is referred to as a ‘no hit’. These ‘no hits’ most commonly occur:

* when an incorrect social security has been entered;
* after a recent marriage or name-change when credit files may not be fully updated; and
* with youthful drivers or immigrants who may have no established credit history.

In the event of a ‘no hit’ situation, the insurance company providing the quote will automatically default to the highest-risk insurance tier (and premium) for the risk in order to offset their inability to pull data and accurately determine the correct premium and risk category.

When Are Insurance Scores Re-Evaluated?

Generally speaking, insurance scores are automatically reevaluated each time a policy is renewed or when a new insurance quote is requested. You cannot request that an insurance company reevaluate your insurance score mid-term during the time that a policy is already in force. It will be reviewed only at renewal.

Do All Insurance Companies Use Insurance Scores?

Yes and No. All ‘standard’ insurance companies utilize insurance scores when determining premiums and quoting news risks. However, there is a separate part of the insurance market, referred to as ‘non-standard’ companies, which do not normally use this scoring model and which may operate with different underwriting guidelines and under a different section on the state insurance code. These companies specialize in those individuals and businesses with either low FICO and insurance scores, excessive loss histories, or which represent an increased risk. Examples include drivers with no prior insurance, numerous accidents and moving violations, or those without a state-issued driver’s license (such as a Mexican National with a Mexican ‘Matricula Consular’ – which is issued to Mexican Nationals living outside of Mexico). The excess and surplus lines market is also considered ‘non-standard’.

The companies doing business in this part of the insurance market offset their risk in not using insurance scores by reducing the available coverage options available in their polices (thereby substantially reducing their risk in the event of a loss) and by establishing initial ‘base premiums’ which are usually much higher than those found in the standard market.

As someone who specializes in commercial insurance and risks, one of the most common statements I hear clients make is that they don’t have any employees, they only use ‘subcontractors’. They assume that by paying people on a 1099-basis that they are being smart and hiring ‘independent contractors’; thereby avoiding the many entanglements that may arise from hiring someone as a true W2 employee.

To get right to the point, this is WRONG WRONG WRONG. Is that clear enough?

Your misinterpretation of a worker’s real employment status can cost you thousands of dollars.

As a business owner or investor, you probably hire people on a fairly regular basis either for part-time or seasonal assistance or as full time help, and like many small employers, you want to avoid paying payroll taxes, you don’t want the ‘responsibility’ of an ‘employee’ and you choose to pay on a 1099 basis and then call these workers ‘subcontractors’ – but are they really – or do you simply assume they are ‘subcontractors’ because you don’t pay their taxes?  What’s the real difference between a W2-employee and someone paid on a ‘1099’ basis? What happens is this ‘subcontractor’ becomes ill or gets injured related to the work?  Can he or she sue you for wrongful termination or discrimination? Do you need worker’s compensation? Are they entitled to any benefits you offer and can they come back against you for not providing them as you do to your other W2 staff?

To put a common myth to rest at the start, you need to understand that paying someone on a 1099-basis and making them responsible for their own employment taxes each year  is does not automatically make them a subcontractor or independent contractor. The ‘1099’ versus W2 is only a concern for the IRS in regards to which party is responsible for paying payroll tax. That’s it. Either they pay their payroll taxes or you do.  In the event of an injury or litigation, it’s the Department of Labor that determines employment status based on some established criteria listed later in this article.

Here are a few things every business owner should know about hiring people as independent contractors versus hiring them as employees.

1.    The IRS uses three characteristics to determine the relationship between businesses and workers:

• Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.

• Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job.

• Type of Relationship factor relates to how the workers and the business owner perceive their relationship.

2.    If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees.

3.    If you can direct or control only the result of the work done — and not the means and methods of accomplishing the result — then your workers are probably independent contractors.

4.    Employers who misclassify workers as independent contractors can end up with substantial tax bills. Additionally, they can face penalties for failing to pay employment taxes and for failing to file required tax forms.

COMMON INSURANCE-RELATED QUESTIONS

Should I purchase worker’s compensation insurance?  I only use subcontractors.

Probably. As mentioned above, your assumption of what a subcontractor is versus the reality of his or her employment status are probably two different things. If someone you are paying on a 1099-basis becomes ill or sustains an injury related to his or her employment and the employment status is determined to be as an employee, you are legally responsible for all medical costs, lost wages, future lost wages, etc, regardless of who is paying the employment taxes.

How does the money I pay 1099 employees affect my general liability premium?

If you are paying your ‘employees’ on a 1099 basis and you have reported them as ‘subcontractor payroll’ on your general liability insurance, your premium is probably higher than it should be as subcontractors are rated higher for liability premium purposes. Reclassifying them as ‘employee payroll’ (assuming this is the case) should reduce your premium some.

VIEW THESE OTHER RESOURCES

Employment Status Comparison Chart (1099 vs. W2 Employees) 

IRS Publication 1779 – Independent Contractor or Employee

To get right to the point, there is no one-size-fits-all policy and properties which are either vacant or held for sale at the time an insurance policy is applied for cannot be written with a standard-market insurance carrier and they require different types of coverages. The following information may seem overwhelming if you are not familiar with the insurance industry, but it is intended to give you a basic understanding of why coverage for vacant property is more expensive and how it differs from the other property policies you may be more familiar with.

A Note About Vacant Property Coverage

First of all, no standard ‘big name’ insurance carriers such as Farmers, Allstate, Safeco, Travelers, State Farm, etc. will issue new policies of any type on properties that are either vacant or actively held for sale at the time of issue unless they are rental properties scheduled to be occupied within the next thirty days.  Their underwriting guidelines and ‘appetite’ (an insurance term indicating the risks a company is currently interested in writing business for) specifically prohibit, in very clear and precise language, these types of properties.  The reason for this is that vacant properties and those actively held for sale represent a much greater likelihood of loss due to vandalism, theft, arson, unrepaired water leaks, and similar circumstances.  From the insurance company’s standpoint, the best way to avoid paying for these losses is to simply not accept the business.

If an agent were to issue a new policy on a property that the carrier prohibits and the carrier learned of it through a property inspection or because of a claim, the agent could lose his appointment and contract with that carrier.  In addition, if there was a loss, the carrier would legally deny the claim altogether and cancel the policy ‘flat’ since it should have never been written in the first place per their existing underwriting guidelines and the fact that the property was vacant or for sale was not revealed would be considered ‘material misrepresentation.’  The agent could then face fines and administrative action from the state’s Department of Insurance as well as errors and omissions issues from the customer.  In addition, the customer would be left without any coverage for the loss and he or she would have to pay for all all repairs or property replacements out of his or her own pocket.

The Dreaded (and Often Ignored) Vacancy Clause

One caveat to vacant property coverage occures when a previously-occupied and currently insured property becomes vacant, such as when a tenant moves out.  All standard-market carriers have a very specific clause, known as the ‘vacancy clause’ written into their dwelling policies which deal with this situation.  Each carrier’s clause is a bit different, but they are similar in their intent to reduce the carrier’s exposure to a loss.

In short, if a previously-occupied property becomes vacant for a period of more than 30 days (60 days with some select carriers), the policy either (1) automatically cancels altogether so that there is now no insurance in place or, if the clause is written in such a way as to keep the policy in force, (2) all coverages <water damage, loss of rents, vandalism, etc> are terminated with the exception of coverage for fire and lightening only. Once the property is reoccupied the original coverages are returned.

Where to Get Coverage For Vacant Homes and Property Held For Sale

While standard-market insurance carriers will not issue new business on vacant or for-sale properties, coverage is still readily available – but you will have to pay much more for it and the coverages are greatly reduced.

Policies for these types of properties are written through the ‘Excess and Surplus Lines’ market (referred to as E&S), which many agents know little or nothing about.  In addition, agents are required by law to obtain special licensing and education in order to use this market (which fewer than 3% do). Simply stated, this is huge multi-billion dollar insurance market specializing in high-risk, unusual, or hard-to-place risks such as vacant property, commercial property, general liability, and numerous other coverages that the ‘standard’ market does not have an appetite for.  This E&S market is comprised of specialty domestic insurers as well as ‘syndicates’ made up of overseas companies, most notably Lloyds of London. How these carriers and syndicates work is another topic for another article, but suffice to say that it’s complicated.  Also, because of the nature of their high-risk business, these companies do not advertise directly to consumers and you have probably never heard of any of them, although they are usually extremely financially-stable with hundreds of millions of dollars held in financial reserve.

In order to obtain coverage for a property that is vacant or for sale, you must find an agent that is very knowledgeable with regards to the E&S market and that already has established relationships which enable him or her to write this type business (InsuranceForInvestors has numerous E&S markets available).  This is fairly uncommon as the majority of agents have limited industry knowledge and they often focus only on simple home, auto, life, and health insurance.

Also, once you have found someone who understands what it is that you need, you will probably be required to fill out paper applications and the agent will then submit them to the carriers for review.

Most of the policies cannot be quoted online by an agent and, once submitted, it may take anywhere from the same day to several days to get a quote back because the E&S market almost always requires a manual underwriting process because of the unusual and varying nature of the risks that they write – the agent has little or no control over this process. This means that there is very seldom any sort of online rating program or automation which can immediately produce a bindable quote for you.

Unique Characteristics of E&S Policies

As you may have already guessed, there is a very big difference in the actual policies for vacant and for-sale properties than for standard dwelling policies, one of the most notable being the premium.  The following list represents some of the major differences that you will need to be aware of.

Premium Amount

The premium for vacant and for-sale properties is always much more expensive than a standard policy because the premium charged reflects the type of risk insured.  This premium can be anywhere from 30% to 200% higher depending upon the property, prior loss history, and coverages desired.  Also, because of the manner in which E&S carriers are structured, they are usually ‘non-admitted’ to the state in which the property is located, which means that they are required by law to charge state tax and filing/stamping fees.  In addition, they may charge policy fees ranging anywhere from $75 to $250 or more (again, depending on the carrier, the risk, and the premium amount).

Minimum Earned Premium (MEP)

All E&S carriers also have a ‘Minimum Earned Premium’, which is normally 25% of the base premium amount not including the taxes and fees.  What this means is that at least 25% of the pure  base premium is considered to be ‘earned’ by the carrier at the very moment the policy is issued, even if it is only in force for one day.  For this reason, all of these policies require at least a 25% non-negotiable down payment at the time of issue. For example, if a policy were issued with a total premium of $ 1,176.50 ($ 1,000 base premium + $ 100 policy fee + $ 76.50 tax), then 25% of the base premium ($ 250) would be considered immediately ‘earned’ and it, along with the fees and tax of $ 176.50 would be due as a down payment in order to start the coverage.

The earned premium, taxes, and all fees are always considered non-refundable.

Premium Financing

E&S carriers are not set up to manage regular monthly billing cycles and they require that the policy premium be paid in full, usually within 15 days of the policy issue.

To prevent having to pay the premium balance in full and to establish a more manageable monthly billing for customers, third-party companies which specialize in the financing of insurance premiums are utilized.  Although they work together closely to avoid coverage lapses and billing issues, these specialty finance companies are often unrelated to the carriers themselves and they serve as a third-party intermediary managing premium payments.

Just like when purchasing a care, when the policy is issued, a financing agreement is signed and the down payment (which is paid by the customer and includes taxes and fees) is sent to the carrier issuing the insurance. The remaining balance is then provided by the finance company to the carrier (on behalf of the customer) and the customer then repays the finance company in regular installments. If the customer is late on payment or fails to pay, the finance company notifies the carrier which, in turn, sends a cancellation notice to the customer.

Policy Terms

Many policies for vacant or for-sale properties can be written in either in 6-month or 12-month policy terms, depending upon the carrier.  The reason for this is simple; if a property is being sold or is currently vacant, the assumption is that it will either be occupied or sold in the near future so why should a customer have to pay for a 12-month policy if the property might reasonably be occupied or sold within the next 90 days?  If you need to extend the term of a policy for any reason, this is easily done.

Differences in the Coverage Provided

There is a tremendous difference in coverages provided between standard dwelling policies and those issued for vacant properties.  While the common loss of rents and loss of use coverages are not provided (because the property is not occupied and they are therefore, irrelevant), there are many other differences of which you should be aware.

Vandalism and Malicious Mischief (VM&M) – Because it is the most likely cause of loss, most E&S policies do not include coverage for vandalism and malicious mischief for any reason, though there are some carriers which will offer to include it – for additional premium.  If you do have a carrier offering to provide this coverage, you can expect to spend several hundred dollars for it.

Accidental Water Damage – Very few vacant property policies include any coverage whatsoever for damage caused by the accidental discharge of water.  While coverage for water damage is often included in dwelling policies for tenant-occupied properties, this coverage is specifically excluded and cannot be endorsed (added) back to pollicies used to insure vacant dwellings. Having said that, there are a few rare cases where some companies may allow you to purchase this coverage for an additional premium, but those additional premiums are often two or three times more than the basic policy premium itself and the coverage becomes cost-prohibitive for most investors.

Theft – Theft coverage is often provided in policies for vacant properties, but you will definitely want to ask the agent to be certain as it is not an absolute guarantee that it is included.

No liability – policies for vacant and for-sale properties often do not include liability coverage to protect you against legal issues and lawsuits arising from injury or other issues arising on or from the property.  If you desire liability coverage, you will be required to purchase a separate liability policy or pay much more for a policy which does include liability coverage.

In summary, properly insuring vacant and for-sale properties is a very specialized and unique niche which requires a great deal of knowledge on the part of the agent issuing the policy.  The coverages are greatly reduced over those afforded to normal occupied property and it requires that you, the investor, have a good understanding of the risk as well as what coverages you are, and are not, receiving with the policy that you are purchasing.

The biggest problem with this method of obtaining property is that there are almost no remaining ‘assumable’ loans left in the market and the mortgage loans used today strictly prohibit another party from assuming this debt. While many investors still create these assumption-purchase scenarios in order to easily obtain a new bargain property, the fact is that they are trying to ‘skirt’ the system and they are taking a calculated risk that the underlying mortgagee either won’t find out that the loan has been assumed or else they simply won’t care so long as the mortgage is being paid.  In either case, it’s a gray area at best and property insurance is really not designed to be used in these types of scenarios; which only adds another complication.  Simply put, there is no ‘perfect’ or ‘clean’ way of insuring these properties unless your agent is willing to risk his license, pay fines, lose appointments with insurance carriers, and violate the law.

Insuring ‘Subject-To’ property is often tedious because investors do not want to trigger the ‘Due On Sale’ clause, found in modern mortgage loans, by sending the mortgagee a new insurance declaration’s page with a named-insured different than that of the original owner (remember, this is ‘skirting’ the established mortgage system).  The reality regarding this concern; however, is very, very minor.  The most common question is “Won’t the underlying lender call the loan due if they find out that I now own the property“?  Technically speaking, they could.  Practically speaking, they won’t.  Banks are in the business of making loans, not collecting houses, and as long as payments are being made they usually don’t care whose making them.  As we already said, banks don’t want houses, they want payments, and as long as they have a performing asset they are not going to call the loan due in order to give up their on-time payments in return for a non-performing asset which now costs them money.  This is especially true in the current market.

Unfortunately, many real estate professionals and ‘gurus’ (which know absolutely nothing about insurance laws and some of which we actually know) teach that the homeowner’s policy should be kept in place with the ‘seller/owner’ and that the investor should actually purchase a second policy for their ’new’ insurable interest.  This supposedly keeps the mortgagee in-the-dark about the transaction and makes everything clean for the new investor-owner.  This is wrong!  Sure, it can be done, but the reality is that in the event of a claim it will probably constitute both loan fraud (since the mortgage terms have been intentionally violated and the mortgagee not notified of the new sale) as well as insurance fraud (since all parties have knowingly double-insured the property to avoid disclosure to the lender).

First of all, depending upon the state the property is in, it is either illegal or in violation of state insurance laws and regulations to have duplicate coverage on the same property.  Just like you cannot have two insurance policies for your car, you can’t have two insurance policies for the same property.
Secondly, you cannot maintain a “homeowner’s” policy with the seller listed as the named-insured on a non-owner occupied residence no longer titled in the original owner’s name, this can be considered insurance fraud if there is ever a claim and although the seller’s name is on the original mortgage loan, you (the investor) are technically the new owner on title and unless you are living in the home as your own personal residence, this is going to require a new dwelling (not homeowner) policy.

Third, another reason you don’t want to have the seller continue to maintain his or her current insurance as the ‘named insured’ is due to the fact that he or she is no longer the actual owner. Again, this is fraudulent.  It’s true that the seller is still responsible for the underlying loan because he or she signed the original Promissory Note, but the property is no longer titled in the seller’s name – hence the seller cannot legally purchase or pay for the insurance.  Also, if the seller did keep the insurance in place and listed you (the investor/owner) as an ‘additional interest’, only the liability protection of the policy is extended to you and the seller still has ownership and complete control of the policy and the seller is then the only one who can make changes or file claims and he or she is legally entitled to any and all claim settlements and refunds from the insurance company.

In summary, although it’s probably not what many investors want to hear, you (as the new owner) must obtain a new dwelling policy with your name listed as the ‘Primary Insured’.  There is usually no other way.  While many agents and gurus may give you different information, tell you what you want to hear, or may issue policies however you want it done, the truth is that they are incorrect and, if there ever is a claim (the whole point of having insurance), it will probably be denied flat and the policy canceled because it was mis-written and, in some cases, illegal.  We’re investors ourselves and we understand what can happen.

If you have the home in the name of an LLC or other entity, this entity should be listed as an ‘Additional Interest‘ (NOT the ‘Additional Insured‘ in most cases – there is a blurry legal difference in these terms that actually matters).  All property and liability coverages should carry over to the entity listed as the ‘Additional Interest’ while, in many cases, only liability protection extends to ‘Additional Insureds’.  Also most carriers will not allow a policy for personal residential property to be issued with a commercial or corporate entity as the Primary Insured.  Why?  Because in addition to the carrier’s potential legal issues later on in the event of a claim, that defeats the purpose of it being issued as residential personal property, it would then be considered a ‘commercial venture’ and that’s what commercial policies are designed for. We specialize in investment and ’Subject-To’ properties and we can help with all of your investment property and key-person insurance needs.

If you are an investor and you have ever purchased a rehab property using only ‘builder’s risk’ insurance – you’d better continue reading.  Few people, including investors and full-time real estate professionals, have any real understanding of what property insurance is, the various coverages used, endorsements, and, most important, exclusions.

First Things First

To begin with, there is no such thing as ‘full coverage’ insurance for anything, especially real property – period.  Got that?  ‘Full-coverage’ implies that you are completely covered for any act of nature, man, or God, and that is absolutely not true as there are ALWAYS ‘exclusions’ written into any and all policies; 100% of the time, that you are not protected against.

What is an ‘Exclusion’

Exclusions are those items specifically outlined in the details of the policy (in the conveniently apt-named ‘Exclusion’ section) that specifically list what your policy WILL NOT cover or indemnify (reimburse) you for.  Items such as war, nuclear explosion, intentional acts, government action, environmental pollution, and several others are pretty standard although each policy differs, not to mention the difference that exists from state to state according the state’s own regulatory insurance laws.  It is imperative that you read through these exclusions in order to understand what you are NOT covered for (instead of finding out when it’s too late) and then ‘endorse’ or request any additional coverages that you may desire to be protected against for your own unique situation.

What is an ‘Endorsement’?

An endorsement is an ‘addition to’ or ‘change within’ the policy that affects the coverage that the policy currently contains, whether it is to increase monetary coverage limits, add additional items to be covered, change the type of indemnification from Actual Cash Value (ACV) to replacement cost, and many other items.

Using a homeowner’s policy as a simple example, let’s assume that you own a house with $200,000 property damage coverage for hail, fire, wind, etc.  Generally speaking, the contents inside your house such as furniture, bedding, electronics, etc. are usually protected at a default amount of 50% of the property damage coverage limit, which in this case is $200,000, so you would be covered for up to $100,000 for your interior contents so long as they were damaged due to a covered peril (a ‘covered peril’ is one ACTUALLY LISTED in writing your policy as being covered and NOT contained in the ‘exclusions’ section.)

However, if you decided that it would cost you more than $100,000 to replace all of your furniture, clothing, cookware, personal items and so forth (say $125,000), you could add an ‘endorsement’ to change the $100,000 coverage limit that you have by default to $125,000 – you might just have to pay a slight higher annual premium (which varies by company).

Okay, those are the two big insurance terms that we are concerned with at this point, now shall we continue?

Various Types of Policies

As we continue, please know that this article is not going to delve into the various types of policies available for all situations, those are far too complex and that subject is for another article at another time (however, you can always contact us to discuss any and all insurance or asset-protection issues on a personal one-on-one basis.)

Without going into umbrella coverage and proper limits of automobile insurance, there are only really two general types of property insurance policies that you should be aware of; Builder’s Risk and Dwelling Policies, and almost every investor that I have worked with has been SEVERELY under-insured (if insured at all) and unaware of their exposure to extreme financial loss (this is what happens when you purchase policies over the phone from a licensed ‘order taker’.)

BUILDER’S RISK POLICIES

A Builder’s Risk policy, which is the type most commonly used by investors, is ONLY for use by contractors performing work (hence the term “Builder”) and many investors are under the dangerously mistaken assumption that this is the only thing that they need to purchase when remodeling or ‘rehabbing’ a property.  THIS IS DEAD WRONG.

A builder’s risk policy, unless written through non-standard companies, has NO LIABILITY coverage whatsoever for claims against injury, accident, animal attacks or anything similar and it is only designed to insure buildings and dwellings that are under renovation or construction and to protect any building supplies and tools that are in, on, or within 100 feet of the premises.  In other words, you are paying for a policy to protect the contractor’s tools, trailers, building supplies, and materials against loss – and that’s it.  He should send you a ‘Thank You’ card at the end of the job.  Although some builder’s risk policies cover you against theft, vandalism, and malicious mischief, you are NOT covered against fire, water damage, wind, hail, etc. and you have no protection against lawsuits arising from the personal injury of others that may be injured on your property for any reason.  If you are acting as the contractor (by actually working on the property yourself), then this type of policy will protect you against loss of your own tools, equipment, and building materials that are stolen, but you still have no liability and you are wide open to financial and legal loss.  Some of the basic features of a builder’s risk policy include:

• Building supplies of the insured (what you paid for) are included in the policy limit;

• Building supplies of others are subject to a $5,000 limit;

• Includes coverage for scaffolding, cribbing, and other temporary structures on-site;

• Contains standard exclusions as do other policies;

• You can insure the full value of the completed building or increase the coverage limits as work increases;

• IMPORTANT: Coverage automatically TERMINATES either 90 days after construction is completed or 60 days after the building is occupied or put to its intended use, whichever comes first.

DWELLING POLICIES

A Dwelling Policy on the other hand is what most investors actually need – including while the property is being renovated.  This type of coverage does contain various limits of liability coverage to help protect you and it is used mainly for rental properties and NOT for homeowners since a homeowner’s policy is used only for insuring a person’s primary residence.

The key features and benefits of a dwelling policy (and there are several types depending upon what perils, ‘endorsements’ and coverage limits you desire) include:

• It contains liability insurance to cover bodily injury and property damage for which you are legally liable and it will pay medical payments incurred within 3 years of an accident (this does not cover the insured <a.k.a. ‘you’> or your tenants, just employees, guests, passers-by, and all others);

• It also contains ‘supplementary payments’ protection at no extra cost (if you chose to accept the liability coverage on the policy).  ‘Supplementary payments’ means that you also get:

o Bonds paid with no limit (except up to $250 for bail bonds);

o First aid expenses at the scene of an accident with no limit;

o Interest gained on judgments against you (also with no limit);

o A ‘loss of earnings’ feature to pay you up to $200 per day to assist in defending yourself or investigating a claim;

o Expenses incurred at the request of the insurance company (such as expert witnesses, special investigators, etc that are used when defending you against a claim), and most importantly;

o It covers defense (legal) and investigation costs (with no limit)

In addition, a dwelling policy protects your property against loss arising from any of the ‘covered perils’ listed in the policy such as wind, hail, fire, vandalism and malicious mischief, theft, and several more up to the coverage limit that you choose.

In order to be considered eligible for this type of policy, a property must be only one to four units (SFR to fourplex) and, if a mobile or manufactured home, it must be tied down or permanently affixed by means of having the wheels removed and the tongue cut off.

Again, speaking in general terms about what a dwelling policy covers in regards to property loss, the following bullets are a few standard coverages that are usually included as default amounts in the policy; although each may be increased or changed by adding and endorsement and paying a slightly higher premium:

• ‘Other / Separate Structures‘ such as sheds, workshops, and detached garages are usually limited to 10% of the coverage that you have on the primary dwelling;

• Personal Property (such as appliances) is also limited to 50% of the limited to 10% of the coverage that you have on the primary dwelling;

• Fair Rental Value (used to reimburse lost rental revenue) is limited to 10% of the coverage that you have on the primary dwelling;

• Loss of Use (used to cover additional living expenses required to allow the household to maintain their normal standard of living) is limited to 20% of the coverage that you have on the primary dwelling.

In summary, you get what you pay for and you need to make sure that you get what you need.  The world of property insurance is very confusing and full of misunderstanding due to the many endorsements, exclusions, risks, perils, and other insurance-related terms that are contained within whatever policy your purchase.  This is compounded by the fact that so many consumers have been trained to only look at the ‘bottom-line’ premium as opposed to the actual coverage and protection that they are paying for. In addition, people rely on professional agents to provide them with adequate coverage for their own situation, unfortunately however, many agents act as nothing more than licensed over-the-phone order takers less concerned with their customer’s actual needs than they are selling another policy and making their monthly production quota.  If your agent has no real-world experience as an investor or business owner and he either cannot or will not sit down with you and explain, in detail, how you are protected against loss (and how you’re not), then you may consider seeking out a professional agent who will work with you so that your best interests are always considered first.

When purchasing an insurance policy, especially general and professional liability, there are two different types of policy forms to choose from; ‘Occurrence’ and ‘Claims-Made’.  While as a consumer you may have never heard of either of these insurance terms, they can have a huge impact on how (or even if) you are covered when a loss occurs.

‘Occurrence’ forms cover losses that happen (occur) during the time that the policy itself is actually in force. The loss can be reported months or years later after you have switched companies or the policy is no longer in effect, the key is when the loss actually happened. If it occurred while the policy is in force, when it is actually reported in the future is irrelevant.  Occurrence forms, in the opinion of this author, are more valuable because they respond to claims brought about years later.

A ‘claims-made’ policy differs in that it only covers claims that are made while the policy is in force.  If a claims-made policy expired on February 1^st and a claim was submitted for work performed on January 1^st, there is no coverage because it was made outside of the policy’s effective term.

As the name indicates, ‘claims-made’ policies provide coverage only for those claims made during the time the policy is in force. These policies provide coverage only so long as you continue to pay premiums for the initial policy and any subsequent renewals. Once premiums stop, the coverage also stops for any claims not known or made to the insurance company during the coverage period.  What this means is that there is a risk of an unknown or unreported claim being made long after the policy period expires and it not being covered because the claim was made outside of the coverage period.

As you may imagine, moving from one type of policy to the other can be difficult – and dangerous.  A claims-made form is okay is the right situations, but it has no guarantee of continued insurability, so if you are, for some reason, cancelled by an insurance company or you decide to shop prices and you switch to another policy to save money, you may not have coverage in the future for work or activities performed in the past. Some important aspects of ‘claims-made’ policies that you should be aware of include:

• the retrospective date;
• extended reporting periods;
• and ‘tail’ coverage (explained below), just to name a few.

If you do move from one insurer to the next with ‘claims-made’ coverage, you must (should) purchase tail coverage or your new insurer must (should) include a prior acts endorsement. With this endorsement, the new insurer assumes coverage for the prior acts occurring in the other carrier’s coverage period.

Generally speaking, ‘claims-made’ policies usually cost less than an ‘occurrence-form’ policy, but you run the risk of not being covered for a potential claim because you didn’t discover it until after your policy expired. As with all other aspects of insurance, the decision is a gamble or calculated risk that you as the insured party must make, and you will usually pay a higher premium in order to lower your risk.

‘Tail coverage’, which may cost more if you want to purchase it, picks up where a claims-made policy leaves off, covering occurrences that happened while the policy was effective, but claimed after the policy expired. As a result, the combination of a claims-made policy and tail coverage looks very much like an occurrence policy, with one critical difference. When an occurrence policy expires, the premiums stop while the coverage (on occurrences that happen during the policy period) continues indefinitely. Tail coverage, on the other hand, is something you purchase after your claims-made policy expires; and you continue to pay for it until you decide that the risk of discovering an old occurrence no longer outweighs the cost of the tail coverage premium.

To put it more simply, the cost of an occurrence policy is high, but fixed, whereas the cost of a claims-made/tail coverage combination is initially lower, but of longer duration and potentially of higher total cost. The decision of which to buy effectively hinges on the nature of your perceived risks.

Full tail coverage (which can sometimes be up to 200% of the policy’s annual premium) is essential when you retire from business or when he or she changes insurers or policies. When changing insurers, you must carefully consider the ‘true cost’ of cheaper coverage (due to its limited exposure) against the other cost of purchasing “tail” coverage from your old carrier.

If your business or work is such that any liability is immediately apparent – and thus claimable – you are probably safe with a claims-made policy.  However, if your potential liability can go undetected for a long period of time, such as with a company that pours residential foundations which may fail three years in the future, then you may be best served with an occurrence policy.

Basic ‘tail coverage’ is sometimes free of charge but covers only those claims that have been reported during the policy period or 60/90 days thereafter and while the original limit is not yet exhausted.  Supplemental ‘tail coverage’ must be purchased to cover claims that were not reported during this period.  Both coverages apply only to claims stemming from injuries or damage that occurred during the policy period back to the retroactive date.  It does not cover claims that occurred prior to such date, nor those occurring after the policy expires.

Occurrence Coverage

‘Occurrence’ coverage, as already mentioned, is insurance that provides coverage for the act when it occurs – regardless of when it is reported. If you had coverage under an occurrence policy in 2005 and the claim is reported today (the foundation dropped, improper wiring caused a fire, etc) then the claim is covered.

‘Claims-Made’ versus ‘Occurrence’ – Which Should You Choose?

To most insurance consumers, this whole topic can be more than a little confusing.  In an effort to simplify the decision-making process of which policy type is right for you, you should look at the major differences below.

• Premium Cost – ‘Claims-made’ policies are often much less expensive than ‘occurrence-based’ policies. The premium difference can be negligible or, depending upon the carrier, it may be as much as 50% or more.

• Coverage Amount – Under an occurrence policy, coverage is the amount of coverage under the policy in the year of the occurrence. So, if you were just starting out in business or you were trying to save money and you opted for only $100,000 of coverage versus the standard $1,000,000 used by most policies, you may be under-insured against a claim (and legal fees) arising in the future for you work or activities performed in the past.  A ‘claims-made’ policy covers you at the level of insurance you have when the claim is made.

• Long Term Cost – If you begin with a ‘claims-made’ policy from the start, it may be cheaper in the long-term if you maintain this claims-made coverage from now on as you may save a great deal in annual premium each year over an ‘occurrence’ policy. However, if you begin with an ‘occurrence’ form, you should make certain that your initial limits of coverage are adequate to cover any future claims that may arise years from now.  You may pay more in premiums, but you have the peace of mind in knowing that you will always be covered against losses occurring during this policy period.

• Choice of Insurers – This is more important that it may first appear. Believe it or not, insurers can and do go out of business for any number of reasons.  It is uncommon, but it does happen. If you elect coverage from an insurer with a lower AM-Best financial rating, there is a chance that the insurer may become insolvent and that it may not be around to address any claim that may be filed against your policy in the future – which means that you are uninsured. If you have purchased an ‘occurrence’ from a lower-rated insurer and that insurer becomes insolvent three years after your policy expires, and then a claim resulting from a latent-defect is made in the fourth year, you have no insurance protection.

• Type of Business – Certain businesses or industries must have occurrence policies or have a risk policy in place that guarantees the purchase of prior acts endorsements and tail coverage without fail. Construction businesses (including ‘rehabbing’ and remodeling) where defects may not be discovered for years are good examples of candidates for this type of coverage. Other businesses have a much lower risk of claims occurring much past the transaction with the customer (such as a mechanic) and can safely choose ‘claims-made’ coverage.

• Availability- Since ‘occurrence’ coverage keeps may not be available in your state, industry, or profession. It may be prohibitively expensive. ‘claims-made’ coverage is more readily available.

If you would like to discuss your commercial insurance needs or if you need more clarification regarding claims-mace versus occurrence-based policy coverage, call our offices at (512) 986-6124 and we’ll help you find the best solution for your insurance-related needs.

Property owners may offer seller-financing for several reasons, the most common being that the owner himself is financially-burdened with a property or is facing foreclosure and is unable to sell it, for any number of reasons, on the open market.  By offering seller-financing terms, the idea is to have someone else (the new buyer) assume the debt in a ‘roundabout’ way to avoid the impending financial implications. 

While the idea of an owner seller-financing a property is appealing to many sellers in order to move a property, little or no thought is given to insuring a property purchased in this manner – and this is where the legal problems begin.

Commonly known as a ‘wrap-around’ mortgage, this article isn’t intended to address the potential issues relating to due-on-sale clauses or trigger-documents, but rather we will discuss only the insurance-related aspects to this type of scenario.

The Seller’s Goal

To begin with, the common goal of the seller in this type of situation is to get out from under the financial burden of a property by offering seller-financing as an incentive for a new buyer to complete a contract and close on the property.  The owner ‘sells’ the property to the new buyer (thereby becoming the buyer’s mortgagee), usually by the means of a ‘wrap-around’ mortgage, and the new buyer then makes monthly payments to the seller.  The seller, in turn, then takes this money and makes the existing payment to the underlying or original mortgagees (usually a standard financial institution or bank).  In most cases, these payments are handled and processed by a third-party note management company.

The Buyer’s Goal

The goal of the buyer, who more often than not has credit challenges or can’t come up with a large enough down payment to secure a traditional mortgage loan, is to be able to purchase a new home and eventually refinance the loan to a lower interest rate after his or her credit has been improved or after a history of occupancy and payments have been established.

The Typical Scenario

The typical scenario is that

• the original seller has an existing mortgage with his or her original lender, such as Wells Fargo, Bank of America, or any other bank or lending institution.  
• The owner will sell the property to a new buyer by use of a regular promissory note and wrap-around mortgage (which ‘wraps’ around the existing loan and includes the cost of the new loan to the new buyer), 
• the seller then becomes the buyer’s mortgagee for this new transaction (the seller’s original loan is still in place between the seller and his or her bank).  
• The new buyer makes monthly payments to his or her mortgagee (the seller), and the seller in turn takes this money and pays his or her underlying loan installment.

 The Legal Problems

The problem with insuring a seller-financed property can be significant source of concern for both the buyer and seller for a number of reasons:

(1)  The new buyer, and only the new buyer, must obtain a new homeowner’s policy in his or her name, listing the seller (and possibly the original lending institution) as a mortgagee, in order to protect his or her personal property, provide liability coverage, and to protect the financial interest that he or she has in the property.  The premium for this policy may or may not be escrowed by the seller depending upon the financing arrangements. 

(2)  ONLY the policy owner (aka ‘named insured’) may file a claim, modify or terminate a policy, or receive claim-related payments.  This means that only the new buyer can file a claim or receive payments if necessary. 

(3) The seller of the property must legally cancel his or her prior homeowner’s policy since he or she is no longer the titled legal owner and is no longer ‘owner occupying’ the property.  Homeowner’s policies are ONLY for properties used as a primary or secondary residence and maintaining this coverage in place can be considered insurance fraud in the vent of a loss since it is a ‘material misrepresentation’ on the insurance contract. 

(4)  The primary issue or problem is that the original underlying mortgagee (ie: Wells Fargo) is the first-position mortgagee and the original promissory loan and mortgage that are in place are a legal contractual agreement between the lender and the original borrower (in this case the seller), regardless of what transaction may have occurred after this fact.  The original mortgagee still assumes that the original borrower is on title and both occupying and maintaining the property.

Scenario # 1 – The Original Mortgagee

• Each year on the anniversary date of the original homeowner’s policy that was supplied when the property was first purchased, the original mortgagee (Wells Fargo) is going to require an updated policy declarations page and proof of payment (if not already escrowed).  The mortgagee requires that this declaration’s page MUST be issued in the name of the original borrower that is on the promissory note and mortgage still in place with the mortgagee.

 When a property is seller-financed, the new homeowner’s policy is in the name of the new buyer, NOT the original buyer.  This means that a policy declaration’s page with the original borrower listed as the ‘named insured’ is not available.

(1)  it is illegal for your agent to knowingly fabricate a false declarations page on your behalf or to knowingly issue or maintain a homeowner’s policy on a property that he or she knows is no longer owner-occupied.  The agent’s license could very well be revoked by the state department of insurance and he or she could face substantial financial penalties for committing insurance fraud. 

(2)  if the original mortgagee sees a declaration’s page issued in the name of a party other than the original borrower, they may well use their legal option of calling the loan due payable in full by use of the ‘due on sale’ clause included in the promissory note and/or mortgage document.  This means that the original mortgagee forecloses on the original borrower (ie: seller) and the NEW buyer(s), who are an innocent party in this issue, are then forcibly removed from the premises and they in turn lose all money and financial stake they have in the property. 

(3)  The new buyers may then file a civil lawsuit against the seller.

Scenario # 2 – In The Event of a Claim (New Buyer)

(1)  In the event of a claim, all claims checks and payments are made out jointly to the policy holder (named insured) as well as to the mortgagee.  This is a security measure designed to help prevent insurance and claim fraud and the mortgagee must endorse check over the insured in order for it to de deposited. 

(2)  If the new buyer filed a claim, such as a roof claim due to hail damage, and he or she had listed the seller and original mortgagee on his or her policy, the claims check will be made out to the policy owner and both mortgagees, which means both mortgagees must endorse the check. 

(3)  If the original lending institution or mortgagee was unaware that a private sale had taken place, they are now notified and the ‘due on sale’ clause is triggered and the issue described above may occur. 

Scenario # 3 – In The Event of a Claim (Original Owner)

In the event that there was a property claim (fire or hail for example) and the original owner / seller chose to somehow maintain his or her original homeowner’s policy in place in order to ‘outsmart’ the system and avoid notifying the mortgagee of the recent sale, the following events may well occur:

(1)  The claim is filed by the seller under his or her homeowner’s policy, 

(2)  The carrier’s claims adjuster reviews the claim, investigates property records, and determines that the property is not occupied by the insured and that the policy is in place fraudulently, 

(3)  The claim is denied, the policy cancelled flat, and the original mortgagee notified of the policy cancellation and possible fraud. 

(4)  The ‘due on sale’ clause is triggered and the legal issues already described get set in motion. 

In summary, there is no ‘exact’ way to insure property financed with a wrap-around mortgage, regardless of how clever or well-documented a transaction may be.  The major reason is that an insurance policy is a straight-forward legally-binding aleatory contract made between the named-insured party and the insurance company and it is intended to indemnify (‘make whole financially’) the insured party in the event of a loss and it is not designed to be manipulated or modified based upon the insured party’s business transactions.

If you are a real estate investor, or if you have ever remodeled an existing property, the chances are better than not that you have either purchased or heard of a ‘Builder’s Risk’ insurance policy.  The question; however, is whether or not you were ever really protected with any insurance at all.

You see, contrary to its name, a Builder’s Risk policy may not be applicable in many remodeling and construction projects and this is the most commonly mis-sold policy in the market – which means that thousands of people each year pay for insurance which they never really even have.

Some Important Facts to Know

(1)  Builder’s Risk policies can often be written in terms of three-months, six-months, or 12-months.  If the project is not completed by the end of the initial policy term, it can often be extended, but only one time;

(2)  While there are exceptions, it is also important to know that a Builder’s Risk policy usually does NOT provide coverage for any existing property undergoing structural changes or renovations such as foundation work, movement or alteration of load-bearing walls, roof trusses, or new property additions.  While this is often the exact nature of the work being performed on existing structures; these items are often specifically excluded and any claim filed on a property which has had this work performed may be immediately denied and the policy declared null and void.  In essence, you’ll have no insurance.

(3)  Third, all Builder’s Risk policies are considered ‘earned premium’ due the high-risk nature of insurance.  What this means in laymen’s terms is that the entire premium for the policy must be paid for up-front and in full at the time the policy is issued.  Also, this premium is immediately considered fully ‘earned’ by the company, which means that even if you cancel the policy three days after it is issued, you will get no refund whatsoever as the premium has already been ‘earned’.

(4)  Also, unlike a normal homeowner’s policy, Builder’s Risk is not designed to protect against personal liability nor does it cover any losses which occur before the project is actually started or after it is completed.   This means that if anyone, such as a neighborhood child, is inadvertently injured on the property and the parents or others choose to file a lawsuit, the insured has absolutely no liability protection unless he is also covered by a completely separate General Liability policy.

(5) Finally, a Builder’s Risk policy automatically cancels and ceases coverage either 90 days after the project is completed or 60 days after the property is put to its intended use (whichever comes first), such as in the case of a rental property in which a new tenant signs a lease and moves in.  In the event of a claim after the project is completed, the insuring company can request copies of tenant leases, occupancy permits, or other official documents in order to establish when the project or construction was completed.

Why Do Agents So Often Mis-Sell Builder’s Risk Policies?

The reason so many agents incorrectly write and issue Builder’s Risk policies under the wrong conditions is not because of anything intentional, more often than not it’s simply because the agent you are working with has little or no experience in real-estate investing or anything construction-related. In addition, many agents who have developed their business around selling traditional home and auto policies have seldom, if ever, read through a Builder’s Risk policy to actually understand what is really covered and what isn’t.  Therefore, they naturally assume that a Builder’s Risk policy is a one-size-fits-all policy for anything and everything construction-related.  It’s only when the unexpected occurs that you find out you weren’t properly insured.

What is a Builder’s Risk Policy for?

Generally speaking, Builder’s Risk Insurance covers buildings and structures under brand-new ground-up construction or minor remodeling of existing structures, such as interior remodels and ‘gut rehabs.’  It typically covers the same types of things as regular property insurance, such as damage from theft, fire, vandalism, wind, hail, and other accidental loss or damage to the property.  A Builder’s Risk policy also provides coverage for theft or damage to materials not yet installed, such as uninstalled windows, cabinetry, lumber etc.

As already mentioned, there is no liability coverage and coverage usually extends until 90 days after the building or structure is completed and/or 60 days after it is put to its intended use.

What It Isn’t Used For?

A Builder’s Risk policy is not intended to be used for long-term coverage. It is also not intended to be used for properties which are occupied during the course of construction (except minor remodeling work).  Finally, they are not intended for use on vacant or properties actively held for sale.

Who Needs It?

Who should purchase a Builder’s Risk policy?  Anyone with a financial interest in a major construction, remodeling, or repair project, including general contractors, real estate developers, and property owners.  In addition, some trade associations and lending institutions may require Builder’s Risk Insurance, especially on projects worth a million dollars or more.

Other Things To Take Into Consideration

Builder’s Risk policies don’t cover damage arising from earthquakes or floods, so if you need this coverage you will have to purchase it separately.  Also, as already mentioned, most Builder’s Risk policies do cover loss or damage to construction materials in transit and in storage, so if you plan on storing or transporting construction materials, make certain that this coverage is provided. 

Additional Coverages You Need To Be Aware Of

Contactors’ equipment and tools typically aren’t covered by the owner’s Builder’s Risk policy and these risks will usually require separate coverage.  One caveat to this is that many policies do actually provide a limited amount (usually $5,000) for tools and equipment which are stolen or vandalized, but they must be within 100 feet of the property at the time of the loss itself.  They may or may not also cover “soft costs” associated with other aspects of a project such as financing charges, marketing, legal, permitting, and loss of income resulting from property damage.

Summary

In closing, Builder’s Risk policies are very different and the coverages they contain can vary greatly from one insurance company to the next and it is very important that when needing a Builder’s Risk policy, you work with an agent who is knowledgeable with regards to these coverage types.

Troy Insurance Group is extremely experienced in construction, commercial development, and real estate investing as well as all matters relating to Builder’s Risk coverage.  For a free quote or to discuss the insurance needs of your particular project, call us at (512) 986-6124 for more information.