"YES VIRGINIA, THERE IS AN INSURANCE CRISIS"
Or, As Our Insurance Broker Friends Like To Say, "Please Don't Shoot The Messenger!"
by Beth A. Grimm, Esq., and Garth Leone
nsurance professionals (brokers) who have been in this business a long, long time say that the current insurance crisis in California is "cyclical." This cyclical process, in the "old days," apparently occurred every five to seven years. We are in the raw end (or beginning) of such a cycle. The insurance market is fast becoming an extremely "hard market," meaning that that insurance can be hard to get, is increasingly (in some cases, exponentially) more expensive and coverage is declining for the rate paid. If this concept (the "cyclical" nature of things) is true, that's about the only good news-it will pass eventually, not unlike a stubborn and painful kidney stone. According to some insurance representatives, homeowner associations merely need to "weather the storm." Whether the actual problem is cyclical or simply indicative of changing times, associations need to understand what is happening so denial does not prevent forward thinking and planning for what we will tell you in this article.
What exactly is happening?
Essentially, there is a reasonable explanation for rising insurance costs, higher deductibles, less coverage and new exclusions. The most troubling problems in the insurance industry, which keep the insurance companies from having the kinds of profits that they like to enjoy, are in several identifiable areas:
- Construction defect insurance for developers.
- Malpractice insurance, errors and omissions insurance.
- Problems related to health care and workers' compensation coverages.
- Directors and officers liability coverage.
- 9/11 losses.
- The waning economy and problematic stock market.
- Mold claims, the latest flurry of concern.
However these problems arose, the bottom line is that insurance companies want (or should we say need?) to make a profit. It has become more and more difficult to sustain the profits of the past 10 to 12 years. Increased "reinsurance costs," higher than expected "loss ratios" and, of course, the glory days of "easy investing" behind them, carriers are struggling to maintain profitability. For the past 10 years or so, carriers have basically ignored "rate" as a means to increase profit. They merged, acquired, reorganized, re-positioned, recalculated, re-merged, re-invented, etc., all the while making hefty return on investing our money. As the investment profits began to fade in early 2000, the operating costs (particularly "reinsurance costs") began to skyrocket. Actually, these reinsurance costs have been steadily rising since late 1998, but because the investment income was so good, many carriers were able to weather the increased costs of reinsurance without going for "rate." Now, unfortunately, as the costs have gone from a steady rise to a steep, steep upward trend (meaning doubling and tripling the cost of reinsurance) the carriers have no choice but to come back to the policyholders for "rate."
Now that we've mentioned "reinsurance" several times throughout this article, you may be asking yourself, "What exactly is this 'reinsurance' stuff they keep talking about?" Well, the generally known carriers (like Farmers, Allstate, Travelers, Allied, etc.) cover a certain portion of each risks, and then purchase excess protection (called "reinsurance,") The formula (while quite complex in detail) can be simply explained this way. The carrier you know (like Travelers, for example) insures your association for $10,000,000 for "property damage." They have a "reinsurance treaty" with, let's say Swiss Re, that says Swiss Re will pay for any single loss at any single location that exceeds $5,000,000. This is called the "attachment point" meaning Swiss RE "attaches" to any loss at any one location that exceeds $5,000,000. So, if you have a $7,000,000 fire at your $10,000,000 complex and Travelers insures you and Travelers has the "treaty" I described, Travelers would pay the first $5,000,000 for that loss and Swiss Re would pay the remaining $2,000,000 for that loss. The "massive increase" we alluded to earlier is actually two-fold. The "Swiss Re's" of the insurance world are saying to the "Travelers" of the insurance world things like this "Hey, Mr. Travelers, the cost of that reinsurance treaty is going up by 100 percent and, oh yeah, did we mention that we are only going to "attach" at $10,000,000 now?" The "umbrella" of sorts (backup - and cheaper - protection) just got raised twice as high as it was before. This means Travelers has to carry more of the risk, meaning it will have to charge more, because it will not be able to get the reinsurance protection to cover any part of this particular $10,000,000 policy. Reinsurance is characteristically less expensive than the primary risk because the "pool" for the reinsurers is bigger. With that kind of shift in the reinsurance market place, some carriers who do not have the resources to handle the increased risk ("higher attachment" equates to increase in exposure), will suffer in the insurance "ratings" to the point of not being a viable market for insuring commercial property. Thus, the "pull out".
So, what does this mean to homeowner associations and the people who own property in them?
- Increased premiums!
- A need to collect additional assessments!
- A need to tighten up on claims adjustments and especially water leak and intrusion problems!
- A need to reevaluate (and reassess!) insurance coverage and deductibles!
- A need to revisit risk management!
- A need to communicate with owners to help them help you and to understand the situation!
So, details, you ask?
Increasing Costs Trigger Need for Increasing Assessments
Obviously, associations are going to need to raise money to pay premiums for insurance that is required by the CC&Rs;. There may be questions that arise as to how much the association can collect for "voluntary" types of insurance, but those policies that are mandated by the CC&Rs; leave no questions. The association has various options to collect money for insurance. In assessing whether rights exist as to "voluntary" vs. "mandatory" polices, the association should seek individual legal advice; this article is to raise awareness, not give advice to any particular association. In order to address the general question related to where the money comes from, there are a number of possibilities:
1. Borrowing From Reserves: Some managers recommend that associations borrow from the reserves to pay unanticipated insurance premiums (when sufficient funds were not budgeted). This would likely be an acceptable way to pay unexpected increases in premiums (although questions arise as to what is going undone if the reserve money was earmarked or needed for facilities or repairs). It would probably work well for an association that is able to "recover," through an increase in assessments or a special assessment paid over the coming year's time to replenish the reserves. Keep in mind that when this borrowing occurs, the association has to make specific findings as to the need and adopt a plan to repay the reserves within one year and ensure that the minutes of the board meeting when this action occurs reflect this (per Civil Code Section 1365.5). The statute requires that "The board shall exercise prudent fiscal management in maintaining the integrity of the reserve account," so no willy-nilly or irresponsible borrowing is allowed! Associations would generally do well to communicate this information to the owners through a newsletter or distribution of a letter of communication (although the statute does not require disclosure beyond the minutes record), so that this practice does not get challenged unnecessarily by someone who simply does not understand what the reality of serving on the board is.
2. Increasing Regular Assessments, Imposing A Special Assessment Up To The Legal Limits: An association is entitled, by law, (per Civil Code Section 1366) to increase regular assessments up to 20 percent a year without a vote of the membership. Associations may also impose a special assessment that does not exceed 5 percent of the budgeted expenses for any given year, without a vote of the membership. These assessments are considered in the "aggregate," meaning that if there has been a regular assessment increase, or special assessments imposed earlier in the year, they need to be considered at the time the association is considering using this method to pay for or recoup costs of insurance premiums.
3. Emergency Assessment: For any insurance premium increases that are unanticipated and extraordinary (which seems to be happening a lot these days), and which exceed the legal limits for raising or imposing assessments, the association would likely be entitled to impose an emergency assessment without a membership vote. To impose an emergency assessment, findings are required indicating the extraordinary nature of the need, and the inability to foresee or budget for same. This will only work well for the surprises, folks! These findings are required to be sent to the owners. Before any association assesses an emergency assessment, legal advice should be sought as to how to go about the process, and how the association's records must be documented.
4. Reassessing Risk and Insurance Needs: The board needs to take a close look at the association governing documents and determine exactly what insurance is required, what is voluntary, and what is prudent. The association should examine its insurance coverage each year and determine if changes are needed, even if a policy does not expire. The association needs to keep a copy of all insurance policies, and this is generally done through the management office. However, tracking down insurance policies is often more work than it should be; waiting to get a policy is interminable, especially when there is an emergency. Most insurance agents do keep an "agent's copy" on file but sometimes that is simply a renewal certificate for the original. The change in the Civil Code Section 1365 insurance disclosure a few years back mandates that associations keep copies of policies accessible for unit owners' review and copying (at the unit owner's expense). To that end, many brokers have been trying to step up the level of "delivery" for policies to the manager or the board to advise them of this requirement. In the past client copies too frequently got filed in a dark drawer somewhere, never to be found again, especially when an association shifted from one management company to the next. Now, however, at least with many of the better-organized association management companies, the policies are being better maintained. The policies belong to the association and need to be properly stored and maintained for emergencies. Unit owners Expect board members to be able to answer the questions "When/Where/How can I get a copy all of the policies that affect my unit?"
While assessing insurance needs, the balance on the fulcrum is assessing risk. Perhaps some of the money needed could be used for other purposes (like fixing water leaks). Risk assessment became quite the vogue after the Northridge earthquake, when EQ premiums hit the roof. Retrofitting was never so popular. Risk assessment was the key. Without a risk assessment, it is difficult to assess the entire amount of risk.
It would be good to take matters a step further. Associations need to work with their insurance professionals, managers, and attorneys to formulate good policies for gaining entry, conducting periodic inspections, following up on water leak/damage/intrusion reports, pursuing responsible parties, setting up insurance claim-making policies so that requests go through the board, adopting policies related to deductibles, perhaps raising deductibles to a higher ceiling so the small claims that lead to being dropped are eliminated, making sure owners fix problems that are their responsibility (perhaps through a follow-up policy similar to architectural control policies that call for follow-up inspections to assure that work is completed), etc., etc., etc. Gone are the days when an association receives the insurance proceeds from a claim, or determines an individual owner is responsible to make repairs because of an overflow or backup in the bathroom, and writes a letter to an owner, sends the proceeds (if any), tells the responsible owner that they (by the way) are responsible for the deductible amount of the claim (if one) and/or for fixing the problem. If common area is involved (or threatened in any way), an association needs to be proactive about investigation and follow-up! The call for claims management, especially as the market tightens and the concerns around mold increase, needs to be: When dealing with any kind of water intrusion, make sure it gets fixed immediately! If there is resistance to the fix, do it and figure out who is going to pay later! [The latter opinion is that of the authors and may not be the opinion of all attorneys and brokers-consult your own experts.]
We cannot stress enough how one seemingly small water intrusion can turn into a HUGE mold claim and ultimately a massive increase in costs of insurance for your association. Start the process today-tighter action, reaction and policies, policies, policies!
Beth Grimm is a community association attorney in California. She is East Bay Resource Panel chairperson, author of various publications and books about condominium living and the law and a frequent contributor to the ECHO Journal. Garth Leone is an insurance broker and a principal at Willow Glen Insurance Agency. He is a past chair of the East Bay Resource Panel and a frequent speaker at programs on CID insurance issues. (copyright 2002, Beth Grimm)>
By Beth A. Grimm, Attorney. A "service oriented" attorney and member of ECHO and CAI and various other industry organizations in California and nationally, host of the website www.californiacondoguru.com; two Blogs: California Condominium & HOA Law Blog, and Condolawguru.com Blog, and author of many helpful community association publications which can be found in the webstore on her site.