5 Reasons a Community Might Be Underinsured
While no community hopes to face a fire, severe storm, or other major disaster, the right insurance policy helps ensure that homeowners' associations (HOAs) have the funds needed to recover. Unfortunately, some policies are underinsured and may fail to adequately cover potential losses.
Most understand that insurance premiums have increased in recent years. However, property improvements, inflation, and labor costs ultimately determine whether a policy offers sufficient protection. A policy that was appropriate a few years ago may no longer reflect today's costs. Keep reading to learn what it means to be underinsured, why it happens, and how to fix it.
What Does “Underinsured” Mean?
When an HOA insurance policy is underinsured, the policy limit isn’t high enough to cover the cost of necessary repairs, replacements, or rebuilding following an insurance claim. This happens because, over time, insurance policies are affected by various factors, altering coverage levels even if the policy limit is appropriate at the time of purchase.
5 Reasons a Community Might Be Underinsured
HOA boards often assume that their insurance coverage will properly protect their community for years to come, but that may not be guaranteed. Insurance coverage limits can decrease from year to year for a variety of reasons. Here are five of the most common reasons a community may be underinsured.
1. Irregular Policy Reviews
Association boards are responsible for regularly auditing insurance coverage. If reviews are delayed and policies aren’t consistently monitored, the risk of failing to protect the association following an emergency increases. Boards should reach out to a qualified professional to help identify coverage gaps a few months before renewal.
2. Recent Renovations or Improvements
Capital improvements often increase replacement values. Whenever your association completes significant upgrades, notify your insurance carrier. Accordingly, they can then update your policy to match the cost of the changes. Projects that commonly affect replacement costs include:
· Renovated clubhouses
· Upgraded fitness centers
· Security gates or access systems
· Pool resurfacing or expansion
· Playground replacements
· New landscaping features
3. Focusing on Market Value Instead of Construction Costs
Many boards focus on tracking property values relative to their insurance costs rather than on reconstruction costs.
Property values are based on the prices of land, location, and the supply and demand for housing. In contrast, construction costs evaluate the price of labor and materials for reconstructing a home, building, or amenity. With market changes, the price to reconstruct can be significantly higher than the originally insured value. To avoid being underinsured, focus on replacement-cost valuation over market value when calculating your needed insurance coverage.
4. Increase in Local Construction Costs
When costs for building materials, labor, and other construction-related expenses rise in a region, insurance premiums also increase to supplement those costs. This happens because major claims often require repeating the construction process. The following factors can increase construction expenses over time:
· Inflation
· Supply chain disruptions
· Labor shortages
· Shifting regional weather risks
Even if an association isn’t actively building, the board should stay informed on construction pricing fluctuations. If construction costs soar unexpectedly, the association may find itself underinsured because its coverage is based on construction costs at the policy start date.
Local contractors can easily provide an appraisal on the limited common property of your association. A standard cost estimator system can also be used by your insurance agent. If the construction is newer, a developer or builder should be able to provide accurate replacement cost information themselves.
5. Outdated Insurance Appraisals
Insurance appraisals for community associations should be scheduled on an annual or biannual cycle to update replacement costs. These pre-loss appraisals evaluate building size, materials, labor, and other factors to give communities a more accurate idea of the funds they’d need to cover major repairs.
If your community has never conducted an insurance appraisal, or it’s been years since you’ve had one, contact your insurance company or an independent appraiser to start an evaluation. An outdated appraisal can immediately put you behind in an emergency.
What Happens If Your Community Is Underinsured?
Maintaining adequate insurance coverage demonstrates good stewardship to the community and fosters trust in the board. Operating with an underinsured policy can lead to many issues, including a coinsurance penalty. A coinsurance penalty is a clause in your coverage that reduces your insurance claim payout if you don’t insure a specific percentage of the cost of replacement (usually 80% or 90%).
For example, an 80% coinsurance principle states that if the replacement value of a building in your association is $100,000, you must have coverage that insures at least 80% of that value, or $80,000. Over the years, the cost to cover the building could rise to $150,000. If your insurance was never updated, and an expensive loss occurred, you’d be subject to a penalty based on the amount by which your community is underinsured. This can set off a series of other issues, including:
- Depleted reserves
- Special assessments
- Construction delays
- Increased dues to recover losses
- Reduced financial flexibility
Questions to Ask Your Insurance Agent About Underinsured Risks
Insurance agents can help secure adequate coverage for the community. They should also be able to answer any questions you have about the risks of being underinsured and how their policies are structured to best serve you. To help ensure adequate coverage and minimize the risk of falling short, consider asking your agent:
- What’s the current cost of full replacement for our structures?
- Does our coverage fully cover amenities and upgrades?
- What are our current policy limits?
- Does our coverage have an inflation guard?
- Do we have ordinance/law coverage with parts A (losses for undamaged parts), B (demolition costs), and C (increased costs of construction) to cover the costs of complying with new building policies?
- For developing communities: Are all new buildings accounted for in the association policy?
Community association insurance is so unique and everyone has different needs. To find the best fit for you and your residents, contact the experts at Associations Insurance Agency, Inc. (AIAI) today!
Breaking Down HOA Insurance
Gaining a better understanding of HOA insurance can be challenging, but reviewing your association's coverage and learning how different policies work can help protect both the community and homeowners. For additional guidance, download our “HOA Insurance Coverage Breakdown”. It has all the information you need to navigate general liability insurance, property insurance, directors & officers (D&O) insurance, and more!
This article is for informational purposes only. Additional insights reflect best practices informed by Associa’s insurance experience. Always consult an insurance professional for optimal guidance.
Reviewed for accuracy by insurance experts from Associations Insurance Agency Inc. (AIAI).