One of the most crucial responsibilities of an HOA board is safeguarding the association’s assets. This requires careful financial planning and revenue generation, but also understanding insurance and tax implications.
Without adequate insurance coverage, associations are vulnerable to lawsuits, property damage claims, and liability issues. In fact, according to insurance experts, only about half of all associations maintain insurance, and only about one-quarter of those have adequate coverage. This startling statistic highlights why understanding your insurance needs is crucial for board members.
In this blog, we delve into HOA insurance needs as well as tax considerations. Our hope is to equip your board with the knowledge needed to make informed decisions that protect your community’s financial future.
Contents
- Essential Insurance Policies for HOAs
- Master Policies vs. Individual Policies
- Additional Insurance Considerations
- How to Purchase HOA Insurance
- HOA Tax Implications to Keep in Mind
- Understanding Capital Contributions for HOAs
Essential Insurance Policies for HOAs
The primary goal of insurance is to mitigate risk. For HOAs, this means safeguarding the community’s assets and protecting against potential liabilities. Different types of insurance policies play crucial roles in achieving this goal.
Common policies include:
Liability Insurance
Liability insurance protects the association against claims resulting from injuries or damages occurring on common property. This insurance typically covers legal fees, settlements, and medical expenses related to incidents such as slip-and-fall accidents, property damage, or any other situation where the HOA may be held responsible.
Matters generally excluded from liability coverage include:
- Injuries from automobiles, boats, or aircraft
- Injury to employees arising out of employment
- Injuries arising from discharge of smoke, fumes, or chemicals
- Damages for false arrest, malicious prosecution, wrongful entry, eviction, libel, or slander
- Contractual liability
- Host liquor liability
- Non-owner automobiles
Most of these exceptions can be covered under separate policies or additional riders.
When evaluating liability insurance policies, boards should pay attention to how attorney’s fees are treated. Some policies consider legal fees “inside the limits” of coverage, meaning that attorney’s fees are deducted from the policy limits. These are sometimes called “wasting” policies, as your coverage can waste away depending on litigation costs. For example, if you incur $500,000 in legal fees defending a $5 million claim, your actual remaining coverage would be reduced to $4.5 million.
Comprehensive Coverage
Also known as “all-risk” or “casualty” coverage, this policy insures the HOA for “all forms of physical loss” except for specific exclusions noted in the policy.
Flood Insurance
Flood insurance may or may not be available, depending on the community’s location. In designated flood hazard areas, flood insurance may be required by lenders or secondary lending agencies.
Worker’s Compensation
If the HOA has any employees, such as maintenance personnel or resident managers, it must carry worker’s compensation. In some states, laws require worker’s compensation be carried for contractors who work on the premises, even though they aren’t employees of the association.
Automobile Insurance
If the HOA owns any vehicles, it should carry adequate automobile insurance, including personal injury, liability, property damage, medical, and comprehensive.
Non-Owned Automobiles
If the association only has basic liability coverage, that policy might not cover any damages or liability related to the use of non-owned vehicles. In other words, if a board member or employee uses their personal car for HOA business and gets into an accident, the association may not be protected. To ensure adequate coverage, the association should obtain a “non-owned automobiles” endorsement.
Directors and Officers Insurance
Directors and officers (D&O) insurance is a liability policy that protects HOA board members from personal losses resulting from legal actions or claims made against them in their capacity as directors or officers. This coverage typically includes protection against claims of negligence, mismanagement, breach of fiduciary duty, or errors in judgment.
D&O coverage typically does not cover willful bad acts or intentional wrongdoing. Instead, it’s designed to protect board members and volunteers from claims resulting from decisions made in their capacity as directors or officers, such as architectural denials or rule enforcement actions. Personally, many HOA attorneys recommend never serving on an association board without appropriate D&O coverage in place. While some directors assume that an association’s obligation to indemnify will protect them in the event of a lawsuit, indemnification provisions sometimes won’t provide legal defense for the director and don’t mean much if the association lacks funds for indemnification.
Rain Damage
Rain damage insurance protects property from losses caused by water infiltration due to rain. This insurance typically falls under broader property insurance policies, covering damages resulting from events like roof leaks, flooding, or water intrusion in basements and walls.
Auxiliary Structures
Auxiliary structures such as fences, signs, pools, and carports may not be covered under a standard comprehensive policy unless they are specified.
Glass Coverage
Glass coverage protects against damage to windows, doors, and other glass structures in the event of accidents, vandalism, or severe weather.
Dram Shop Coverage
If the association operates a bar or at any time dispenses alcoholic beverages, the HOA must add a dram shop coverage rider to its liability policy.
Association Personal Property
If the association owns personal property, such as recreation room furniture or pool cleaning equipment, that personal property should be insured to full actual cash or replacement value.
Boiler and Machinery
In a community with a steam boiler, a boiler and machinery policy covers sudden and accidental breakdowns of pumps, compressors, boilers, and motors. This policy also covers damage caused by a boiler explosion.
Umbrella Coverage
A standalone umbrella policy for an association generally extends over the association’s liability and D&O coverage, filling gaps and providing additional protection, often at minimal cost. In a larger association, the increased expense may cost owners only dollars per year while providing millions more in coverage—a difference that could prove vital when a loss occurs.
Title Insurance
Title insurance protects the association from potential financial losses related to defects in the title of the properties within the community. Typically, the community’s developer will purchase title insurance and then deed that insurance over to the association.
Property Damage Insurance
Property damage insurance protects the association’s property from hazards such as fire, windstorms, and building collapse. The coverage is generally included in comprehensive policies.
Product Liability Insurance
Product liability insurance protects businesses and organizations from claims related to injuries or damages caused by products they manufacture, sell, or distribute. An HOA may consider this coverage if it provides amenities such as playground equipment, fitness facilities, or community events that involve food.
Cross-Liability Endorsement
A cross-liability endorsement provides coverage when one unit owner sues another owner or the association for injuries resulting from an accident in a common area.
Master Policies vs. Individual Policies
Master policies are comprehensive insurance plans that cover common areas and shared liabilities within the community. These policies protect the association as a whole.
Comparatively, individual unit owners can obtain a special policy that offers personal property coverage as well as personal liability coverage. This is usually referred to as an “H0-6” policy and helps ensure individual homeowners are adequately protected against potential risks.
Most HOAs carry a master policy but also require that unit owners carry their own liability and personal property insurance. This dual approach helps safeguard both the community and its residents.
Additional Insurance Considerations
When exploring insurance coverage options, HOAs should also keep in mind:
Claims Made vs. Occurrence Coverage
When purchasing liability insurance, particularly D&O policies, it’s important to distinguish between claims made and occurrence coverage.
Claims made policies provide coverage for claims made during the policy period, regardless of when the incident occurred. That means if a claim arises after the policy has expired, it will not be covered. Comparatively, occurrence policies cover any incidents that occur during the policy period, regardless of when the claim is filed.
Replacement Cost
Policies may be written to provide coverage based on replacement value rather than depreciated value. So, in the event of a loss, the insurer will pay the cost to replace or repair the damaged property with new materials without deducting for depreciation.
Inflation Guard Endorsement
An inflation guard endorsement automatically increases the coverage limits over time to keep pace with inflation. This helps prevent underinsurance in the event of a loss.
Building Ordinance Endorsement
Most building codes require that if a building suffers more than 50 percent damage, it be rebuilt in compliance with current codes. A building ordinance endorsement covers the additional costs associated with these repairs.
Waiver of Subrogation
Under a standard insurance policy, insurance companies have a legal right to recover losses from the parties who caused the damage. A waiver of subrogation is a provision in an insurance policy that prevents the insurer from seeking recovery of costs. Every HOA’s master policy should include this provision so that individual owners aren’t potentially at risk.
Co-Insurance
Co-insurance is a provision in an insurance policy that requires the policyholder to insure their property for a specified percentage of its total value. If the property is underinsured at the time of a loss, the insurance company may apply a co-insurance penalty, reducing the payout based on the ratio of the actual coverage to the required coverage.
For example, if a property is valued at $1 million and the policy requires an 80 percent co-insurance limit, the owner must maintain coverage of at least $800,000. If they only insure it for $600,000, they could face a penalty during a claim.
Policy Language Matters
Insurance policies for condominiums can vary significantly between “bare walls,” “single entity,” and “all-in” coverage, each offering different levels of protection for individual units. The differences in cost and coverage between these options should be discussed with your insurance professional, as they can significantly impact both the association and individual unit owners in the event of a claim.
Replacement Cost Valuation
Both the North and South Carolina Planned Community Acts require minimum casualty coverage based on a percentage of the property’s replacement cost. But determining accurate replacement cost can be challenging. Many insurers offer a “stated value” policy, which pays a predetermined amount that may no longer be accurate due to inflation or market changes. A “guaranteed replacement” policy, by contrast, obligates the insurer to pay the actual cost of replacement, potentially providing better protection.
An “insurable replacement cost appraisal” may be necessary to properly value the association’s common property, and such appraisals should be updated every few years. While this might seem an unnecessary expense, in an association with substantial property, the cost of a new appraisal will be far less than the cost of being underinsured.
Ordinance or Law Endorsement
This endorsement protects an association when governmental code changes increase repair costs. For example, if an older building with no sprinkler system is damaged, and current construction codes require sprinkler installation, those additional costs might not be covered without Ordinance or Law coverage.
Demolition Coverage
Some policies will cover reconstruction but not demolition unless there is special coverage. For large buildings, demolition could cost millions of dollars, making this an important consideration for many communities.
Sewer Drain Back-Up Coverage
Most standard policies do not cover sewer back-up issues, which can cause extensive damage to common areas and units. Associations should consider adding this specialized coverage to their insurance portfolio.
How to Purchase HOA Insurance
Appropriate insurance coverage is one of the best ways an HOA can protect its community’s assets. However, with numerous policies, options, and brokers available, the process can feel overwhelming.
To help streamline this journey, the board should:
Step 1: Appoint an Insurance Committee
Your board should form an insurance committee that will be responsible for investigating options and making informed recommendations.
Step 2: Choose a Specialized Insurance Broker
Next, the committee should select an insurance broker who specializes in HOA insurance.
Step 3: Consult with Legal Counsel
Your insurance committee should also consult with an attorney familiar with community association law to understand what types of insurance are required by state law and your governing documents. The Community Associations Institute (CAI) maintains a directory of attorneys who have earned the College of Community Association Lawyers (CCAL) designation, indicating expertise in community association law.
Step 4: Gather Insurance Specifications
The committee should then provide the broker with a comprehensive list of the coverage needs specific to the HOA.
Step 5: Solicit Multiple Bids
The committee should reach out to two or three different insurance providers to request proposals.
Step 6: Make an Informed Decision
After thoroughly reviewing the proposals, the insurance committee should make a recommendation to the board.
Legal Requirements for North and South Carolina Associations
North and South Carolina associations must navigate specific state laws regarding insurance coverage:
For North Carolina homeowner associations created on or after January 1, 1999, state law requires that the association maintain property insurance on common property in certain minimum amounts as of “the first conveyance of a lot to a person other than a declarant.” The North Carolina Condominium Act has similar requirements for condominiums created on or after October 1, 1986.
For stacked condominiums (or units with “horizontal boundaries”), the property insurance requirements are more specific and may require the condominium association to cover individual units. Both the Planned Community Act and the Condominium Act include requirements for specific language that must be included in the association insurance policy.
In South Carolina, similar requirements exist for common property coverage, and recent legislative developments continue to refine these obligations.
Additionally, pending legislation in North Carolina (Senate Bill 491: HOA/Condo Crime & Fidelity Insurance Policies) would require associations with certain amounts of funds, as well as their management companies, to maintain crime and fidelity insurance policies in specified amounts.
Remember that these state requirements represent minimum standards, not necessarily what is adequate for your specific community. Your governing documents may also contain additional insurance requirements that exceed state minimums.
HOA Tax Implications to Keep in Mind
Just like insurance coverage, taxes can affect the association’s overall financial stability. Missteps in this area can lead to unexpected liabilities, fines, and even bankruptcy.
To avoid these pitfalls, HOA boards should be aware of the following tax implications:
Classification of Income
Understand whether your HOA is classified as a nonprofit or a for-profit entity. Nonprofits may have different tax obligations and potential exemptions.
Reserve Fund Contributions
Reserve fund contributions can be classified as capital contributions if certain criteria are met, which can impact tax treatment.
Investment Income Taxation
Any income earned from investments is typically taxable. However, income from municipal bonds may be exempt.
Capital Gains Tax
If your HOA sells property or assets, be aware of potential capital gains taxes.
Deductibility of Expenses
Understand which expenses can be deducted for tax purposes, such as maintenance costs and repairs. This can lower the overall taxable income of the association.
Sales Tax
Depending on your state, certain services or materials purchased by the HOA may be subject to sales tax.
Employment Taxes
If the HOA employs staff, it must comply with employment tax obligations, including payroll taxes.
IRS Form Filing
Most HOAs must file annual tax returns with the IRS, often using Form 1120-H for homeowners associations. Failure to file can result in penalties.
Assessment Income: Understanding Capital Contributions for HOAs
How HOAs manage and classify assessment income can significantly affect the association’s tax obligations. For assessment income to be treated as capital contributions, which have specific tax advantages, the HOA must:
Notify Unit Owners in Advance
To classify a portion of the assessments as capital contributions, the HOA must inform unit owners that specific amounts are being contributed to the reserve fund.
Designate Funds for Future Capital Expenditures
It’s essential for the HOA to set aside reserve fund contributions specifically for future capital expenditures, like roof replacements and major landscaping.
Use Funds Appropriately
The funds that are earmarked for reserves should only be used for significant repairs and replacements, not for everyday maintenance. Misusing these funds could jeopardize the capital contributions classification and expose the HOA to increased tax liabilities.
Segregate Funds
HOAs must maintain separate bank accounts for reserve funds and operating funds. This can protect the association from potential audits or tax implications.
Given the complexity of tax law, it’s recommended that HOAs seek the assistance of a certified public accountant. These professionals can help your board create a financial plan that aligns with the association’s goals.
Let Us Help Protect Your Community’s Assets
Money isn’t everything. But in the world of HOA management, financial solvency can make or break a community. That’s why it’s important for your board to understand the different types of insurance policies available and to also stay informed about tax obligations.
As fiduciaries, HOA board members must approach the association’s risk management differently than they might handle personal insurance decisions. While better and more comprehensive insurance will increase expenses, the protection it provides to the community as a whole often justifies the investment. Insurance is all about balancing risks—the best insurance may be unaffordable, but operating without adequate insurance puts your entire community at unnecessary risk.
Luckily, you don’t have to navigate insurance and taxes alone. As a leading provider of HOA management services in North and South Carolina, Community Association Management empowers association boards with expert-backed resources and solutions. From a suite of customizable community management solutions to cutting-edge HOA accounting services, we are here to help your community thrive.
To learn more about our HOA management services, contact us online or give us a call at 888-565-1226.
The content on this website is provided without any warranty and does not constitute legal advice. For legal advice specific to your community or issue, please consult an attorney specializing in Association Management.
