Risk Management — Part 3

In previous issues we discussed the approaches of avoiding risks and of controlling (minimizing) risks that can’t be completely avoided.  In this issue we will briefly discuss another method of managing exposure to loss – that of transferring risks to other parties.

The most common method of transferring risk is to buy insurance (which transfers some or all of the risk to the insurance company). There also are non-insurance ways to transfer risks.

Insurance

When you insure your home, car, boat, or rental properties you are transferring certain of the risks of loss related to each item to the insurance company. You pay a relatively small amount in premium rather than run the risk of not protecting yourself against the possibility of a much larger financial loss. The insurance company averages its risk of paying occasional large claims over a large number
of premium paying policy holders who have no losses.

Having adequate rental property insurance is an absolute must. One needs different insurance for a rental property compared to an owner occupied home. Both liability and casualty coverages are
significantly different. Liability insurance is even more important for a rental, as you could be held financially liable for damages, injury, or death of your tenants or their guests and service vendors or for anyone else on your property including trespassers even though you have much less control over these people for your rental than for your personal residence.

Recognize the Risks

As for general risk management, the first step toward good insurance protection is to recognize the risks you face. Some landlords will need coverages not required by most other landlords.

Organize Your Insurance Program

As with good risk management in general, good insurance management is achieved through planning and organization. To ensure that you are adequately covered you must seek competent professional advice, recognize the various ways you can suffer loss, and buy adequate insurance economically.

Essential Coverages

While there are a large number of types of insurance coverages available, many ofwhich are very desirable, four kinds of insurance are most essential.

They are: liability, casualty, automobile, and, for some, workers’ compensation.

Liability

Liability insurance covers payment for claims up to policy limits. Liability insurance (particularly for property damage and bodily injury) usually includes legal defense at no additional charge when the policyholder is a party to a lawsuit that involves a claim covered by the policy. In addition to bodily injuries, many liability policies will cover personal injuries (libel, slander, etc.) unless specifically excluded.

Liability coverage can be much more important than all hazard coverages put together.  Exposure to financial loss due to physical hazards is actually limited, although the limit can be quite high, by the value of the damaged or destroyed property. However, loss from liability is only limited by what a judge or jury wish to award.

The bottom line is that you should obtain the highest possible liability limit even if it means accepting high deductibles on casualty coverages.

It is often more cost-effective and otherwise better to increase liability protection through the use of excess liability (umbrella) coverage. An umbrella insurance policy takes over after the limit of another policy has been exceeded. An important feature of an umbrella policy is that it also provides extra coverage for other policies that are covered by the umbrella policy.

Casualty Insurance

Casualty insurance almost always means fire insurance, but usually includes such as windstorm, hail, smoke, explosion, vandalism, and malicious mischief which add very little cost relative to basic fire insurance. If you need comprehensive coverage your best buy may be one of the special policies that offer the broadest available protection for the money.

Flood and/or earthquake insurance may also be desired by the owner or required by a lender.

Automobile Insurance

In addition to adequate insurance for your personal and business motor vehicles, you should carry non-owned automobile insurance. This coverage protects from liability when an employee or a contractor uses a vehicle on your behalf.

If employees will ever use their own vehicles on your behalf, you should also require that they have you named as an additional insured on their policy.

Workers’ Compensation

Landlords who have employees or who hire independent contractors not having liability or workers’ compensation insurance should be particularly concerned that their insurance covers these persons.

Other Insurance

There are a variety of coverages for special risks. For example, there is a coverage that compensates for loss of value due to down-zoning or other legal considerations that prohibit replacement improvements of the same type and/or density following a significant or total loss of improvements.

Choosing Coverages

You must, of course, decide which risks you want to insure against. Some decisions, however, are made at some level of government or as the result of a contract.

As examples, if you operate a motor vehicle on public streets you must be able to prove that it is insured at least to some minimum requirements and mortgage lenders require the borrower to maintain certain kinds of insurance on properties being financed.

Choosing Limits & Deductibles

Insurance premiums can be a significant cost of property ownership, but insufficient insurance can result in financial disaster.  Therefore, property owners must strike a balance between over-insuring and under-insuring. Insurance is a complex and detailed subject, but a qualified agent, broker, or consultant can explain the options and help an owner decide the most important types of coverages, how high a deductible is acceptable, and how large the policy limits should be.

Minimize Insurance Claims

Although a landlord may have good insurance coverages, it is important for several reasons to reduce the likelihood of insurance claims through preventive measures. First, frequent
claims will likely result in the landlord and/or property becoming uninsurable at acceptable costs. Second, when it comes to liability insurance, no practical insurance policy limit is guaranteed to be high enough to cover what might be awarded by a jury. Third, reducing insurance claims will almost certainly reduce risk of damage and injury claims litigation. Fourth, dealing with processing insurance claims and being involved in lawsuits can eat up a lot of a landlord’s limited time, the latter having the potential of being particularly onerous.

Good health, safety and security measures, adequate maintenance procedures, certain property improvements, regular property inspections, special fire prevention measures, mold prevention
procedures, and requiring tenants to carry insurance may eliminate the need for some types of insurance or lead to lower insurance rates. Seek help from people who are experienced in identifying and dealing with risks or have reason to notice problems. One excellent resource is your insurance company’s safety inspector or your local fire department. Another approach is to ask your tenants to identify all safety risks no matter how small.

Many insurance carriers provide premium discounts for various property features related to safety and security.

Finally, it is the insured’s responsibility to immediately notify his/her insurance company or agent as soon as he/she learns about a claim or a probable claim.

Other Insurance Coverages

Insurance coverages that can be used to provide protection against some of the uncertainties of life in general and business in particular include life insurance, health insurance, disability insurance, retirement income, and key employee insurance.

Tenant Insurance

So far in this article we have discussed risk transfer by the landlord purchasing insurance. Transfer of some risk can be further accomplished by requiring tenants to purchase certain coverages that will also provide additional protection to the landlord. For example, commercial leases almost always require tenants to provide insurance including liability and casualty and specify the types nd minimum limits of coverages. Commercial tenants are also usually required to indemnify the landlord from liability claims related to their businesses. Tenants are usually required to have the landlord named as an additional insured on the policy.

Residential lease agreements usually only advise tenants that they should purchase renter policies because they will not otherwise be insured for liability or for loss of personal property.
Occasionally, residential leases do require tenants to obtain renter insurance as a condition of tenancy. It should usually be required when waterbeds, large aquariums, or other special risks will be brought into the rental unit. Although some states may have restrictions regarding which risks can be transferred to residential tenants, many, perhaps most states will allow a landlord to require
each tenant to provide a renter’s insurance policy.

Other Transfers of Risk

There are other ways that landlords can transfer risk besides purchasing insurance. They can transfer risk by having the lease agreement make tenants responsible for certain tasks related to risk
management. For example, although you will want to assure that smoke alarms and carbon monoxide detectors function at the time of tenant move-in and whenever you inspect units, the lease should make them responsible for additional testing and battery replacement (if applicable) during their tenancy.