Here’s what you should know about this practice so that you can protect your HOA and avoid spending unnecessary money.
What’s Forced-Placed Insurance?
Financial institutions that hold a mortgage on association property won’t give in on their requirement that an HOA carry significant coverage for its assets, says Chesler, especially in Florida. “It’s certainly understandable that this is their position,” he says. “After all, a bank took the risk of loaning on an asset worth tens of millions of dollars in an area that’s prone to hurricanes and other types of damage. There will always be coverage on a building–regardless of whether an association wants it or can afford it.
“If an HOA notifies its lender that it can no longer afford the premiums associated with proper coverage, the financial institution will implement a ‘forced placement,'” explains Chesler. “The bank will buy the insurance, and ultimately the owners will pay the premiums through increased assessments, or the premium will be tacked on to the loan amount. The problem is that that can cost the HOA twice the amount it would cost if the HOA were to purchase the insurance on its own. The lender just places the insurance. It’s not concerned with the cost.”
Even Individual Units Can Be Subject to Force-Placement
If your HOA is considering mortgaging or has already mortgaged its real property, like its common areas or common property, the question of force-placement of insurance can arise. Whether your HOA can do that depends on your state’s law and governing documents.
In Florida, association property is typically not mortgaged, says Lisa A. Magill, a shareholder and association attorney at Becker & Poliakoff PA in Fort Lauderdale, Fla. “It’s generally transferred by quit-claim deed from the developer to the association in connection with transition or dedicated to the association by recorded plat.” (But Magill advises board members to conduct a due diligence analysis after the association is turned over from developer control, and one of the tasks of due diligence is to research whether there are encumbrances on association property.)
However, Magill says mortgage lenders do “force-place” insurance on unit owners when they consider an association’s master policy coverage inadequate. “This happens with flood coverage,” she says. “Since many associations don’t carry flood coverage, a lender can require a home or unit owner to obtain the coverage, failing which, the lender binds the coverage and charges the costs back to the borrower.”
Though he has seen insurers force-place coverage on individual unit owners, James R. McCormick Jr., a partner at Peters & Freedman LLP in Encinitas, Calif., who represents associations, has never seen one do it on a California HOA. That doesn’t mean it couldn’t happen. “Some associations have language in their governing documents that prohibit the association from encumbering HOA assets,” he says. “Typically, what they use to secure loans is the association’s income from assessments. But I’m not aware of any statute that prohibits associations from encumbering their real property.”
H. Scott Kerns, president of BayRisk Insurance Brokers Inc. in Alameda, Calif., which insures condos and HOAs, agrees that it’s rare for insurers to force-place insurance on HOAs in California. “But it’s possible,” he adds. “A ‘438bfu’ is a form attached to property insurance policies that gives lenders rights to act on their own to preserve their protections under insurance contracts. So if a borrower fails to pay premiums and a policy goes into cancellation, the lender gets obligatory notification and can then pay the premium to protect its loan.”
Lenders’ right to do that in California, says Kerns, also depends on the wording of certain legal documents. “As far as lenders requiring earthquake insurance, the loan documents and deed of trust will determine whether they can require insurance that they decide is prudent,” says Kerns. “Every so often a lender will try to use the phrase, ‘Or other insurance that [the lender] wants or needs.’ Then the lender tries to stick earthquake insurance into the mix. I’ve never had it become a reality for an HOA, but I have had lenders try to require it. Usually, there are some nasty letters back and forth, but someday it will happen.”
What Can Your HOA Do?
If your HOA has been slapped with fees from insurance coverage by its lender, you have several options.
1. Prove you have adequate coverage.
“You can send the lender evidence that shows the insurance had been in place and there’s been no lapse in coverage,” says Chesler. “If that happens, most banks will back down and take the charges off.
2. Purchase the coverage independently.
“Your HOA can place the insurance itself, and the lender will then charge your HOA for the daily pro rata amount for the time the bank force-placed the coverage,” says Chesler. “But if your HOA is already struggling to pay a mortgage or loan, the costs could put your HOA over the top.”
3. Get a new appraisal.
“In this market, it’s likely that values have decreased, and a new appraisal will be lower than ones done in the past,” says Chesler. “That difference could result in a reduction in your HOA’s premium. The down side is that based on the lower appraisal, your HOA runs the risk of getting a lower payout in the event of a disaster.”
4. Increase your deductibles.
“Many associations today are increasing their deductibles as a way to lower their insurance premiums,” says Chesler. “HOAs know best how much risk they’re willing to take. Let’s say your association has 400 units. The amount of the assessment that would go toward paying the deductible might be only $20 per unit. The board might say, ‘We think the chance of us having a loss is low, and we’ll increase the amount per unit to $40. We really haven’t increased a charge to our unit owners because they pay that amount only if there’s a loss, but our insurance costs go down.’ That places some of the risk back on the homeowners.
“However, if you do this, it’s important you have a plan to fund the deductible and cover shortfalls in coverage amounts,” Chesler adds. “You can do that by building reserves over a period of time or securing a line of credit, though if your association has a large percentage of assessment delinquencies, it’s unlikely a bank will extend a line of credit. Likewise, if the association has a substantial vacancy rate, a credit line won’t be extended.”
Whatever option you take, understand the risks and rewards. “While these strategies can reduce premiums,” says Chesler, “there’s also the possibility they could reduce coverage.”