CHAPTER
14

The Importance of Insurance

In This Chapter

Insurance can be a complicated aspect of the rental property business to understand. On one hand, it’s something every landlord must have. No mortgage lender lends money to purchase a property without the property being insured. It’s so important that once you have insurance, some lenders require your insurance carrier to notify them if the insurance policy is adjusted or terminated.

On the other hand, insurance is something you hope you never to have to use because if you do, it means something happened to your property—a fire or a flood maybe—that damaged or destroyed your property.

Regardless, the bottom line is that you do need insurance, and the right insurance, to protect your property.

Yes, You Do Need Insurance

It’s worth repeating: you need insurance on your rental property. When it comes to buying insurance, you should shop around for it the way you’d shop for a car. Compare prices and try to get the best deal.

All insurance policies and companies are different, and you should customize your policy to cover both your needs and the needs of your rental property. Your coverage and how much it will cost you depend on various factors, including the size and type of your property, when it was built, what you use it for, and where it’s located. If your rental is in an area close to water or a flood plain, for example, you need to purchase flood insurance.

There are also different types of insurance—title, loss of rent, and liability, among others (more on these later)—you might need. These further determine how much you’ll be covered and will have to budget for insurance.

RENTAL REMINDER

You can bundle your insurance policies for your primary residence and your rental property to save money. So instead of buying separate policies, you can bundle them into one, which is usually less expensive.

If you own a condominium, don’t assume the building’s insurance policy covers the inside of your property. Generally, if the building is lost, such as in a fire, the building’s insurance pays to rebuild the building, but it doesn’t pay for anything inside your walls.

If you’re renting your property furnished, tell your insurance agent. Generally, you can get additional coverage for the items inside your property for only $100 to $200 per year. This is an easy and relatively inexpensive way to protect your investment.

Types of Insurance

Different types of insurance are available for residential properties, including the following:

Understanding what’s available helps you ask the right questions to make the best decision for you and your property.

Homeowner’s Insurance

A homeowner’s insurance policy covers your personal home, your possessions, and people in your property. Generally, a standard homeowner’s insurance policy protects the following:

Often, for an additional fee, you can select optional homeowner’s insurance coverage, such as these types:

When you purchase a property, you purchase a homeowner’s policy. However, before your first tenant arrives, change the policy to a landlord’s insurance policy. Failure to make this change and notify your insurance provider that you’re renting the property could result in cancellation of your policy.

Landlord’s Insurance

Just like homeowner’s insurance, this policy covers both the building and the contents. It also can cover your rental property from financial losses. For example, if you’re unable to rent the property due to damage sustained in a fire, you can submit a claim to recover that lost rent.

Replacement-Cost Insurance

In the event of a disaster, your building is a total loss, a replacement-cost policy gives you the money it would take to replace your building at current costs.

Cash-Value Insurance

A cash-value policy is a little different from the replacement-cost policy. In a cash-value policy, if you insure a building you bought for $100,000 and it burns down, the insurance company sends out an appraiser to determine the current market value for your building.

If the building appraises for less than $100,000, you receive the appraisal amount.

Mortgage Insurance

Mortgage insurance protects the lender in case you default on your loan. Depending on your financial situation and how much earnest money you put toward your rental property purchase, lenders might require mortgage insurance. This is especially true if you have less than 20 percent equity in the building.

Mortgage insurance isn’t a policy you can request. You get it only if the mortgage insurance requires it because it protects them, not you.

Title Insurance

Title insurance is important when you buy a property. It protects you against problems with your claim of ownership. Like mortgage insurance, it’s your lender that requires this insurance.

Title insurance guarantees that the title to a parcel of property is clear of any claims or liens, that the title is properly in the name of the title owner, and that the owner has the right to sell or otherwise transfer the property to someone else.

DEFINITION

A lien is a claim one person has on a property belonging to another as security for a debt or obligation.

If there’s an issue with the title, the insurance company pays damages to the new title holder or secured lender, or it takes steps to correct a problem that’s discovered later, such as an incorrect boundary line.

Liability Insurance

Liability insurance protects you from claims of liability connected to your rental property. This coverage is extremely important because it covers your legal costs if you’re sued in a personal injury lawsuit.

Landlords are especially vulnerable of lawsuits because tenants can and will blame you for anything that goes wrong, from them falling down the stairs because one was loose to them being scalded because the water heater made the water in the kitchen sink too hot.

In addition to personal injury coverage, your liability insurance should cover claims of libel, slander, discrimination, invasion of privacy, and unlawful eviction.

The good news is that liability covers the costs of both the money awarded to an injured party and the costs associated with your legal defense. Never, ever rent a property without liability insurance!

Specific Loss Insurance

Fires, hurricanes, floods, and tornadoes can damage or destroy your property. You might be surprised to learn the damage may or may not be partially or completely covered by your main insurance policy, depending on your policy. What additional insurance you need depends on your property’s location. If you live in a designated flood zone, you need flood insurance.

Specific loss insurance covers the cost of replacement, reconstruction, or repair beyond what’s covered by your standard property insurance policy. Policies cover damage to the building, and they might also cover damage to nearby structures, personal property, and expenses associated with not being able to live in or use the property when it’s damaged.

REAL ESTATE ESSENTIAL

Insurance premiums increase based on how much coverage you have and where your property is located. Insurance companies even determine your premiums based on whether your neighborhood is considered a high-crime area. Frequently, an insurance company requires properties located in distressed areas to be inspected on a regular basis to ensure that the property continues to be free from defects that could translate into potential losses. Remember, insurance companies are for-profit businesses. They plan to pay out less than they receive from you in premiums.

Loss-of-Rent Insurance

Loss-of-rent insurance covers you if you are unable to rent your property. But this isn’t just for when you can’t find a renter. Instead, it’s for more serious situations. For example, say your rental property is damaged so severely from a flood that it’s uninhabitable. As a result, you cannot collect rent because the tenant cannot live there until the property is repaired.

Some landlord’s insurance policies automatically include loss-of-rent coverage. Other policies require you to purchase this coverage separately.

Renter’s Insurance

Your property’s insurance policy doesn’t cover your tenant’s possessions or cover them in cases of liability. It’s a good idea to ask your tenants to get renter’s insurance and provide a copy of the policy to you.

Renter’s insurance provides coverage for a tenant’s belongings against loss due to damages from fire, water, or theft. It covers losses such as repair and replacement of property that’s damaged or stolen from places away from home, such as in a hotel room or a parked car. Additional living expenses, such as corporate housing, incurred because the tenant had to leave the rental property due to damages are also covered. Finally, renter’s insurance covers liability claims made directly against tenants because of their negligence.

WATCH OUT

If your tenant files a loss complaint against his or her renter’s policy and the insurance company finds you negligent and at fault for the loss, the insurance company may be able to sue you for the money they paid the tenant.

Accidental Rental Damage Insurance

The insurance industry isn’t static. It continues to evolve and add new and different products all the time to help protect us. Accidental rental damage insurance (ARDI) is the perfect example of this.

ARDI covers damage your renters cause to your rental property. For example, say the tenant turned on the bathtub and got distracted by a phone call. The bathtub overflowed and caused extensive water damage. ARDI should cover this.

Typically, ARDI maximum is set around $3,000. Unlike renter’s insurance, which the tenant purchases to protect his or her own belongings, ARDI protects you from damage the tenant accidentally causes to your property.

Some landlords like to collect a cash security deposit and have the tenant purchase ARDI. Other landlords accept the ARDI in place of an actual cash deposit.

These policies are simple to purchase and cost less than $200 a year. They’re available through sites like Corporate Housing by Owner (corporatehousingbyowner.com).

The Insurance Process

Typically, when something happens to your property, you contact your insurance company and they tell you to submit a claim so you can receive funds to replace or repair your property. Essentially, the claim is an official request for payment as per the terms of your policy. These days, you can fill out an insurance claim online. Before submitting a claim, properly document—both in writing and by taking photos—all the details.

DEFINITION

A claim is a report you file with your insurance company when something happens. This officially notifies them of the damages you want them to cover.

Here’s how to file an insurance claim:

  1. Check out the damage and assess the situation. Be sure your property is secure and that anyone who might be injured receives medical attention.
  2. If necessary, call the police.
  3. Document everything you know about the situation by taking photos and writing notes.
  4. When you know everything is safe and you’ve documented the situation, call your insurance agent as quickly as possible to let him or her know what happened.
  5. Complete an insurance claim form.

Stay in communication with your agent, the adjuster (more on adjusters coming up), and the insurance company to follow the progress of your claim.

Typically, an adjuster will come check out the damage and write up a report, and you’ll receive word on whether your insurance company will cover the cost of the damage and how much it will pay. If it will, there are two ways to process the payment. One way is for you to pay for the repairs and the insurance company then sends you a check for the total repairs minus your deductible. Another option is that the insurance company pays the entire repair bill, and you send them a check for your deductible.

Before you call your agent, however, you really need to ask yourself if you should submit a claim. Keep in mind that if you have excessive and repetitive claims, you might be at risk of being dropped by your carrier or having your rates increased significantly. Before submitting an official claim, call and talk through your situation with your insurance professional. He or she can give you the pros and cons of submitting the claim.

Deductibles

An insurance deductible is the amount of money you have to pay toward a claim before your insurance kicks in and your insurance company pays the balance.

When you purchase an insurance policy, you set the deductible you’ll be responsible for paying. Typically it’s $100, $200, or more. The higher the deductible you’re willing to pay, the lower your premium is for the insurance policy.

DEFINITION

A deductible is the amount you pay out of pocket before the insurance company begins to pay for damages. A premium is the financial cost of an insurance policy, paid either as a lump sum or in installments during the period covered by the policy.

Choose a deductible that works for you financially and allows you to take care of any claim you might have. If you choose a $1,000 deductible, for example, but you don’t have $1,000 to cover it, you may have a problem getting your claim paid and repairs done.

Adjustments

When you submit a claim, an adjuster reviews your property, the claim, and your policy. If the loss is connected to the physical property, the adjuster takes into account the age of the material used at the time of the loss. If, for example, you just put on a new roof and a few months later a hail storm destroys it, the insurance company should pay for a new roof.

However, if you have a 30-year-old roof on your building and hail damages it, the adjuster will look at the life of the roof before approving or denying your claim. If the life of the roof is supposed to be only 15 years, the adjuster will deny your claim and your insurance company then won’t pay for a new roof because it’s older than its useful life.

If you’re halfway through the life expectancy of the roof, the adjuster will note this and your insurance company will pay for half (total cost – depreciation) of the replacement cost minus your deductible.

Payments

A property insurance policy names you as the policy holder and any lender as an additionally insured. This means that, in the event of a loss, the insurance company cuts a check for the loss, and it requires both your signature and the signature of someone of authority from the lending company before you can cash it.

Say your property burns down, and the insurance company pays $100,000 to cover the loss. You have a mortgage for $75,000, so the lender would be entitled to $75,000 before you can cash the $100,000 check. You then receive the balance. This protects the lender from you just taking the $100,000 and not fixing the property they have a lien on.

RENTAL REMINDER

Review your insurance policy on an annual basis. If the value of your rental property has increased, increase your insurance coverage, too. And if you improve a property with upgrades, such as a fire-prevention system, let your insurance company know. Certain upgrades could lower your premiums.

The smart landlord learns to appreciate insurance and isn’t afraid to file a claim when necessary.

The Least You Need to Know