Earthquake Insurance - California Condo Guru

posted 9/25/07 - new!

EARTHQUAKE INSURANCE -
TO BUY OR NOT TO BUY - THAT IS THE QUESTION!
by Beth A. Grimm, Esq.

any community associations have been inquiring whether they should buy earthquake insurance, considering that the costs have become exorbitant. After networking with attorneys all over the state of California that had to deal with the problems involving reconstruction, collection of special assessments, and disputes with insurance companies in the aftermath of the Loma Prieta and Northridge quakes, it is my opinion that associations should purchase earthquake insurance if they can get it, even if the price is high. The reason: Associations that DID NOT have coverage experienced severely exacerbated problems and had a much harder time recovering. Some still have not recovered - and it is years later. My colleagues tell me that the associations that did have earthquake coverage, although none had 100% return, got loans, paid the special assessments needed to meet the deductibles and shortfalls, and rebuilt. The homeowners who have equity in the property and/or wish to rebuild and keep their homes are the biggest losers when there is no insurance. That is because a special assessment to rebuild without any base of coverage is out of reach of many owners and the ones who can pay their share often cannot bear the entire cost for the share of those who give up on their investment and declare bankruptcy or let the bank foreclose.

I have been asked since to speak to many associations about the considerations behind the decision to buy or not to buy - and have shared the floor with insurance representatives that are able to find levels of earthquake insurance that at least provide similar coverage to a major medical policy, in other words, funds that can be used to rebuild above the usual 10-20% deductible. Although the premiums pinch the budget, if one balances the risk against the "investment", the earthquake policy will be "affordable".

By the way, my rule of thumb in 1996-2001 when I first wrote this article (in the wake of the Northridge quake) was that I considered an affordable master policy to be somewhere in the range of $400.00 - $600.00 per year per unit for homes priced in the neighborhood of $200,000.00. With rising values and considering a median statewide markets, and the fact that most homes are now the range of $500,000-$1,000,000 and beyond in value, and rising insurance costs since then, I would consider some layered protection in the range of $1000-$1500 per home per year to be affordable and worthwhile for the EQ coverage. I believe that most associations can work with coverage within or close to this range - even if owners also purchase the CEA policy described below. I base this on my own experience as an attorney and educator, property I own (which includes a condo on or near a fault), and given what I know about earthquake recovery. A board has to take into consideration the interests of the community and not make decisions based on his or her individual interests. And at the same time, if the owners are split somewhere around 50-50 in terms of "lots of equity" vs. "very little equity" (which often seems to be the case), it seems to me the only way to assure that all owners participate in the protection in the event of an earthquake is to procure at the least a basic layer of protection that would kick in if there was serious earthquake damage to the development. At least then, if those with little equity walk away from the property, those who stay have less of a shortfall to fund.

Many boards, when they face the increases coming through for earthquake insurance and the cuts in coverage, immediately react with negativity and their objectivity is lost, because it just seems unfair. Maybe it is unfair - life is not always fair. But it is extremely important to consider the risks involved in saying "NO".

Those risks are:

If there is an earthquake, the board members and association could be sued and the directors and officers liability carrier could very well be in a position to deny coverage on that basis for "failure to adequately insure". This "failure" is an excluded item on many directors and officers liability coverage policies. Insurance companies are not going to let members collect for earthquake losses through another policy such as the directors' and officers' protection.

In many cases, we could be talking about the difference in a $25,000 to $50,000 assessment in an association that has master earthquake coverage as opposed to a $250,000 - $500,000 assessment in an association that does not (based on homes in the neighborhood of $500,000-$750,000 in cost). If any owner cannot withstand the payments on a recovery loan (SBA was the most chosen loan of choice after Northridge) and that person walks away from the property, the others will likely have to make up the difference in many cases. So favoring EQ insurance even if YOU could withstand the total rebuild cost actually helps your neighbor who lives "on the fringe" be in a better position to save their investment.

"Stand alone" coverage which is purportedly being offered for individual homeowners whose associations are uninsured is not a very practical solution, considering how difficult it would be to rebuild one single unit in a four, five or six unit building.

Once your association drops its EQ coverage, it may well be harder to get back into the market even if the costs go down because most insurers have limits on the number of policies or the total risk they can absorb.

If your CC&Rs require that the board purchase earthquake insurance coverage, then failure to purchase it could be asserted as a failure of duty on the party of the board unless the CC&Rs are amended. Deferring the decision on the insurance to the owners by a simple member vote (without amending the documents) could suggest considerable legal exposure for the board and/or the association unless the vote of members results in valid amendment of the document to eliminate the requirement. And even if earthquake insurance is not a CC&R requirement, the idea that boards are generally responsible to protect and preserve property values could be used as a basis for suing. I am not saying that there is any case law (at least none that I am aware at the time of revising this article in September of 2007) confirming that a claimant in a condo or planned development association would be successful based on this theory Š but that would not prevent someone from trying it out as a theory if there was unfunded earthquake damage and no insurance to supplement the rebuilding costs available to the members. For any association that is having difficulty getting earthquake insurance or that is having difficulty justifying the cost and is considering just saying "NO", the following [minimal] steps should be taken in order to enable the board to claim the decision was a "prudent business decision" and protect the Association, and themselves.

The board of directors should investigate as follows:

Obtain risk analysis for type of development and geological location.

Procure multiple bids from insurance companies for earthquake insurance, or from insurance broker who has access to several different companies.

Survey homeowners to see where they stand on the issue (providing them with meaningful facts and information the board has gathered).

Determine whether the costs involved would require homeowner approval (if they are in excess of legal limits for increases in regular assessments or imposing a special assessment).

Make a prudent decision after gathering and considering the information as described above.
The Board should inform members being asked to vote about

The availability of coverage to the association and the cost.

The availability of individual coverage for loss assessment to cover deductible costs and other shortfalls as well as other items such as personal property and move-out costs through the CEA at Earthquakeauthority.com. Note that owners can get "gap" coverage which is better known as "loss assessment" coverage through the CEA (California Earthquake Authority) to pay the assessment they may face in the event of an earthquake. One can purchase $50,000 in coverage to pay their share of the assessment charged to all owners to rebuild. So it's definitely worth providing the information to owners (such as the cost which ranges from about $350-$450 depending on where the condo or attached townhome is located) and the levels of protection.
€ What happens if there is coverage and what happens if there is no coverage if there is an earthquake and the association suffers serious damage. Boards can gather a lot of information from their insurance agent or broker, from the web, and from legal counsel familiar with these issues.

If the association wants to purchase earthquake insurance and the costs exceed legal limits for assessment increases or require a special assessment, then the board must go to the membership to get approval of a majority of a quorum of the homeowners for the money needed to cover the insurance costs under Civil Code Section 1366. The governing documents may require a different percentage of votes to approve the purchase, and/or there may be extenuating circumstances that lead to a decision to borrow from the reserves or consider an emergency assessment for an increase that could not be anticipated in the budget. [EACH ASSOCIATION NEEDS TO BE SURE TO GET LEGAL ADVICE ON THE REQUIREMENT AS THIS ARTICLE IS NOT PROVIDING SPECIFIC ADVICE ON THE REQUIREMENTS, JUST THE INFORMATION ON WHAT IT MIGHT BE.]. The real point is that putting a measure to the members on whether to purchase the coverage or not, or whether to approve the special assessment for the costs, without informing the owners about what the vote really means is, in my opinion, a step short of the minimal duty of the board to take reasonable steps to protect the property values. By writing about the realities on this subject, I have provoked much thought in this area and assisted many boards and owners in fully understanding the downside of dropping earthquake coverage. I have no stake in the insurance industry, and no particular love for paying insurance premiums, but I firmly believe that basing one's decision on whether to seek some protection for one's real estate investment on the odds that there will be no earthquake damage to deal with in one's home ownership in a condo development or planned development in California is pretty risky business.

For those associations waiting for a state program to bail you out on the master coverage issues, stop waiting. The California Earthquake Authority, and any other state program selling residential insurance policies, will not provide coverage for associations because associations must purchase commercial insurance coverage. This is not to say that this is the end of the inquiry. The CEA does provide individuals with a cushion. To read more about this, look for my E-Newsletter on the subject and other articles on the website. I have written simple and complex papers on the subject of insurance coverage. And other things one might consider, as follows. Some associations are considering using the money that would otherwise be used to purchase earthquake insurance for retrofitting. If your buildings could benefit greatly from retrofitting, this might be an option. However, the above considerations still apply. Perhaps if an association must pay exorbitant amounts for layers of insurance to get full protection, there might be a feasible way to combine the purchase of minimal coverage with additional monies being spent on retrofitting.

There are associations considering "self-insuring". To that end, it is wise to consult your CPA and attorney to fully understand the potential tax and other ramifications and statutory requirements and risks on "self-insuring" and consider proper disclosures to owners, board tendencies to find uses for available funds earmarked for something else in an "emergency" or for unbudgeted costs, and all risks, before setting out to build an earthquake self insurance fund. And understand that it will probably take years to sock away what you would have available with the most minimal $2-5million in basic underlying coverage. It is best to consult with your (knowledgeable, I hope) legal counsel and seriously discuss the legal ramifications, and consult with a knowledgeable insurance agent to discuss the options available, before turning your back on the question involving the purchase of earthquake insurance.

By Beth A. Grimm, Attorney. A member of the Bay Area-Central CAI Chapter and (former) Public Relations Chair of CAI's California Legislative Action Committee (CLAC), ECHO East Bay Resource Panel Member (and former Chairperson), and author of FINDING THE KEY TO YOUR CASTLE and other helpful community association publications. copyright 2007, Beth Grimm, all rights reserved.

THE MATERIALS BEING MADE AVAILABLE HAVE BEEN WRITTEN OVER THE YEARS AND DO NOT COVER STATUTES OR CASE LAW OR PRACTICAL ISSUES THAT AROSE AFTER THEY WERE WRITTEN.