Insurance Myths: Does “Full Replacement Cost” Insurance Requirement Really Mean an Association has to Cover Everything?

Nancy Polomis | Hellmuth & Johnson | November 1, 2019

I recently had a conversation with an insurance agent who acknowledged he “didn’t deal much with homeowners associations.” His client lived in an association, and had suffered damage within his townhome that the agent thought should be covered under the association’s master insurance policy.  He believed that, if a declaration states that the association’s master policy must provide coverage for “full insurable replacement cost of the property,” the association must maintain what is commonly referred to as “all in” coverage.  “All in” insurance covers not only the building’s exterior and common elements, but also items on the interior of homes such as cabinetry, countertops, built-in appliances and flooring.  It was not the first time an agent has taken such a position.  Unfortunately for their clients, those agents are mistaken.

Where does the requirement for “full replacement coverage” come from?

The declarations of many associations—regardless of whether the associations are subject to the Minnesota Common Interest Ownership Act (“MCIOA”)—include language requiring coverage for “full insurable replacement cost.”  This requirement is mandated by lender guidelines established by federal mortgage lending agencies such as Fannie Mae, the U.S. Department of Housing & Urban Development (HUD) and the U.S. Department of Veterans Affairs (VA).  The requirement applies to all homes with federally-backed mortgages, but confusion arises most often in homes that are located in community associations.

What insurance does MCIOA require?

Some people seem to get tripped up by the language of MCIOA with regard to the level of coverage to be maintained by the association.  Under MCIOA, the master insurance policy maintained by the association may cover certain components on the interior of a townhome or condominium home, including (i) ceiling or wall finishing materials, (ii) finished flooring, (iii) cabinetry, (iv) finished millwork, (v) electrical, heating, ventilating, and air conditioning equipment, and plumbing fixtures serving a single unit, (vi) built-in appliances, or (vii) other improvements.   However, unless the declaration specifically states that the association must cover any or all of those components, the association is not required to maintain insurance that covers those items.  If there is no requirement to cover these items under the declaration, the decision whether to cover them lies with the board of directors.

Federal mortgage lending agencies all acknowledge that an association may not provide adequate coverage to meet the agencies’ requirement to maintain coverage for “full insurable replacement cost.”  If that is the case, those federal agencies require the homeowner’s personal insurance (commonly referred to as an “HO6 policy”) cover the items not covered by the association’s master insurance policy – including such items as flooring, cabinetry, etc.  The master policy and the HO6 policy then work in tandem to provide the full replacement coverage required by Fannie Mae, VA and HUD.

Why wouldn’t an association’s insurance cover everything?

As we are all painfully aware, insurance rates have risen substantially over the last several years.  Not surprisingly, “all in” coverage is significantly more expensive than lesser levels of coverage.  In many cases, the cost for “all in” coverage is simply prohibitive for an association.  Where associations have the flexibility to choose the level of coverage, many are moving to the more affordable “bare walls” coverage, which covers the building, but not the interior finishes of a home, and is sometimes referred to as “studs out” coverage.  For example, if an association opted not to cover any of the items listed above (flooring, cabinetry, etc.), it is likely that the association has “bare walls” coverage.  Having each homeowner cover the interior of his home ensures that the homeowner gets the coverage for his home that he wants, while helping to reduce the insurance costs borne by the association.

How do homeowners know what’s covered by the association’s policy?

If an association has the option to cover certain components within a townhome or condominium, some people have expressed concern as to how homeowners know what is covered under the master policy.

  • First, MCIOA requires that associations provide an annual report to all members that includes, among other things, a “detailed description of the insurance coverage provided by the association including a statement as to which, if any , of the items [referred to above] are insured by the association[.]” (Minn. Stat. §515B.3-106(c)(5).)[1] Therefore, homeowners receive information every year as to what the association’s master policy covers.  Homeowners can then take this information to their own insurance agent to ensure they have adequate coverage, with no gaps or overlaps.
  • Second, when associations make a significant change in coverage, they typically provide multiple notifications to owners prior to the change taking effect.

Homeowners and associations must bear in mind that that the extent of the association’s coverage is determined by the association’s governing documents (typically, the declaration).  Even if the association has been paying for “all in” coverage, if the declaration states that the association is to provide “bare walls” coverage, then the insurer will cover a loss based on the “bare walls” requirement of the declaration.  (If the association’s agent doesn’t ask for a copy of the association’s governing documents as part of the agent’s due diligence when providing a quote for coverage, that should be a red flag for the board of directors.)  If a homeowner insures his home based upon the association maintaining an “all in” policy, when the declaration provides otherwise, there will likely be a gap in coverage.

In addition, homeowners often assume that any repair costs that are not covered by the homeowner’s insurer will be covered under the association’s master policy.  That is not necessarily the case.  For example, if a homeowner’s insurer pays to replace a portion of the homeowner’s damaged wood flooring, the association’s policy may not necessarily cover the cost to replace all the flooring.  As is the case with master insurance coverage, if a homeowner’s agent doesn’t ask for a copy of the declaration and a copy of the master policy (or at least a summary of the coverage), that should be a red flag for the homeowner.

Cut to the chase:  Does “full replacement cost” really mean an association has to cover everything

Not necessarily.  If the declaration of an association governed by MCIOA includes the language giving the association the option – but the obligation – to provide coverage for interior items (or simply refers to the insurance provisions of MCIOA), the association is not obligated to cover those items.  In order to meet the “full replacement cost” requirements under federal lending guidelines, homeowners must ensure that their personal insurance policy covers those items not covered under the association’s master policy so that the combined coverage under both policies provides “full replacement cost” coverage.

If homeowners have questions about what is covered by the association’s policy, they should contact the association’s management company or the board of directors.

The information in this article is provided solely as general information and not as legal advice.  Receipt of this information or its use does not establish an attorney-client relationship.  Readers are urged to speak with a qualified attorney experienced in community association law when making decisions regarding a specific legal issue.

* Special thanks to Grant Herschberger at Marsh & MacLennan Agency for graciously sharing his expertise during the drafting of this article.

[1] The governing documents of many associations that are not otherwise governed by MCIOA also incorporate the annual reporting requirements of MCIOA.

Court Finds Animals Incapable of Vandalism or Malicious Mischief for Insurance Purposes (and all other purposes, too)

Alex Silverman | Property Casualty Focus | October 31, 2019

I am willing to go out on a limb and say that if asked whether an animal, say, a raccoon, is capable of committing malicious criminal acts, most humans would agree that the issue is beyond dispute. But, alas, most humans would be wrong (apparently it very much can be disputed). There is good news, however. The nation’s courts have been quietly tackling the issue, and, thankfully, they have been able to allay any fear of a raccoon uprising occurring in the near future. A federal court in Pennsylvania recently had occasion to address the issue, and it reconfirmed that animals are indeed incapable of committing “vandalism” or “malicious mischief,” both generally and for purposes of obtaining first-party insurance coverage. See Capital Flip, LLC v. Am. Modern Select Ins. Co., No. 2:19-cv-00180 (W.D. Pa. Sept. 19, 2019).

The Capital Flip case stems from a dispute between Capital Flip LLC and its insurer, American Modern Select Insurance Co. Capital Flip owned property in the Pittsburgh area insured under a “dwelling policy” issued by American Modern. In April 2018, Capital Flip discovered that raccoons (or, perhaps, one especially malicious raccoon) had entered the property and caused substantial interior damage. Capital Flip sought coverage for the damage under the American Modern policy, which covered specific “perils insured against,” including losses arising from “vandalism or malicious mischief.”

According to Capital Flip, the damage was covered because it resulted from “vandalism” or “malicious mischief” committed by the so-called culprit raccoon. American Modern denied the claim and advised Capital Flip that damage caused by animals cannot possibly constitute loss arising from “vandalism or malicious mischief” within the meaning of the policy. Unconvinced by this reasoning, Capital Flip commenced this action against American Modern, asserting claims for breach of contract and bad faith.

In its motion to dismiss, American Modern argued that Capital Flip’s claims failed as a matter of law because raccoons are incapable of committing “vandalism” or engaging in “malicious mischief.” But as noted, reasonable humans can apparently disagree in this respect. Indeed, Capital Flip reasoned, because the policy did not specifically define “vandalism” or “malicious mischief,” it was at least possible that these terms could encompass damage caused by animals. Alternatively, Capital Flip argued that the policy was ambiguous and must be construed in its favor given that these terms were undefined. At a minimum, Capital Flip asserted that this issue was unsuitable for resolution on a motion to dismiss because, unsurprisingly, no Pennsylvania court had ever decided whether an animal is capable of engaging in “vandalism” or “malicious mischief.”

After considering the parties’ arguments, the court declared for the first time in the history of the Commonwealth of Pennsylvania that animals are, as a matter of law, incapable of behaving in the manner required to implicate insurance coverage for “vandalism or malicious mischief.” While the policy did not define “vandalism” or “malicious mischief,” the court found Capital Flip’s reading of these terms to be untenable, and undermined by basic contract interpretation principles. As the court observed, the ordinary dictionary definitions of “vandal,” “mischief,” and “malicious” all require the subject to act with some level of conscious deliberation. The Pennsylvania penal code applicable to Criminal Mischief was similar in this regard. The court explained that accepting any contrary interpretation would require a determination that animals are capable of behaving in ways that simply defy the laws of nature. Refusing to accept such a reading, the court held that the terms “vandalism” and “malicious mischief” clearly and unequivocally presuppose conduct by a human actor.

Other courts have addressed whether damage caused by animals is included within the “vandalism and malicious mischief” coverage of an insurance policy. The Capital Flip court found that each of them has declined to interpret these terms as including animal behavior. Luckily for us humans, it appears that these courts found no evidence to suggest that animals are capable of forming the intent required to engage in the sort of willful conduct contemplated by the “vandalism or malicious mischief” language in insurance policies. Interestingly, in one such case, a New York court held that it only “reluctantly” concurred with other cases finding that coverage for vandalism or malicious mischief is limited to human acts. See Roselli v. Royal Ins. Co. of Am., 538 N.Y.S.2d 898 (Sup. Ct. Monroe Cty. 1989). The Roselli court may have been privy to information about animals these other courts were not, but it reached the same result nonetheless. The Capital Flip court also agreed with that result. Accordingly, it granted American Modern’s motion to dismiss, finding the sole premise of Capital Flip’s claims — that the dwelling policy covers damage caused by malicious raccoons — was legally unsustainable.

Having restored your understanding of nature and contract interpretation, we leave you with this poem by a New Mexico appellate court:

Alas, it is written in the law
That the animal with the paw
Does not have the mind
To do the damage of this kind.
And so, I’m sorry, the Plaintiff won’t get paid.
That’s how the contract was made.
This policy does not apply
When the [raccoon] runs awry.

Montgomery v. United Sers. Auto. Ass’n, 118 N.M. 742 (N.M. Ct. App. 1994).

Asbestos/Duty of Care: Connecticut Court Addresses Construction Project/Liability Issues

Mitchell, Williams, Selig, Gates & Woodyard | October 25, 2019

The Superior Court of Connecticut (Judicial District of Hartford) (“Court”) addressed in a September 30th opinion certain issues arising in an asbestos exposure case. See Julian Poce, et al., v. O&G Industries, Inc., et al., 2019 WL 5295545.

The Court addressed Summary Judgment Motions arguing certain project contractors did not owe mason laborers a duty of care.

Several mason laborers (collectively “Plaintiffs”) were employed by Connecticut Mason Contractors, Inc. to work at certain points on a building project at a high school in Connecticut. They alleged that while working on the building project they were exposed to asbestos.

Plaintiffs filed an action against Southern Middlesex Industries, Inc. (“SMI”) and O&G Industries, Inc. (“O&G”) for negligent infliction of emotional distress in regards to both O&G and SMI. They alleged repeated exposure to asbestos from working in areas of the building project designated by O&G as the project manager. Asbestos was stated to have been disturbed that was present in the floors, walls, and ceilings.

O&G was argued to have had actual or constructive notice of dangerous site conditions/defects, including the presence of asbestos and PCBs. It is stated to have supervised all phases of work along with exercising possession and control of the project. Plaintiffs claimed that even though O&G controlled (or had the ability to control) the means and method of work, the relevant areas were not sampled, remediated or tested for asbestos prior to the Plaintiffs’ exposure. This is alleged to have resulted in asbestos being inhaled by Plaintiffs.

O&G was allegedly aware of the exposure. Further, it was alleged that such exposure was allowed to occur despite an agreement signed with the Town of Wethersfield requiring O&G to observe safety protocols and procedures.

SMI was alleged to have performed demolition work involving asbestos remediation at the site. Plaintiffs claimed that SMI did not properly section off regulated work areas to ensure plaintiffs were not exposed to materials being remediated. This is alleged to have contributed to a lack of adequate testing and sampling of materials including an absence of advance warning to the Plaintiffs.

Both O&G and SMI filed Motions for Summary Judgment arguing that they owed Plaintiffs no duty of care.

Various AIA contract documents along with deposition transcripts were filed in support of the Defendant’s Motion for Summary Judgment.

O&G argued that it owed no duty to the Plaintiffs because issues related to hazardous materials were specifically excluded in its contract from its scope of work. The Plaintiffs responded that legal duty is a question of fact, noting that:

  • O&G supervised safety at the worksite
  • O&G had a duty of care to third parties because it was in control of the site
  • O&G had a duty of care under the Occupational Safety and Health Act Regulations

O&G replied that its contract provided it did not have control over construction means or safety precautions at the site. Further, it claimed that there was no duty under the common law or Occupational and Safety Health Act regulations.

The Court addressed each of these three arguments and granted Summary Judgment concluding that O&G did not owe the Plaintiffs a duty of care with regard to the discovery and removal of asbestos.

SMI argued in support of its Motion for Summary Judgment that it owed no duty of care because it was not hired to identify asbestos. Instead, it argued that the obligation was to remove hazardous materials that had already identified by their contractors.

Plaintiffs responded that an analysis of legal duty ordinarily leads to a question of fact and that SMI was in the best position to ensure their safety. It was argued to have performed its work in such a way as to create hazardous situations and that the company owed a duty of care under Connecticut common law along with the Occupational and Safety Health Act regulations.

SMI replied it had no duty to perform work that was beyond the scope of its contract.

The Court concluded it was evident that SMI was not hired for the specific purpose of identifying and locating hazardous materials. However, it determined this did not establish that it bore no responsibility whatsoever for the identification and discovery of asbestos on the worksite while it performed its demolition or remediation duties. Questions of fact were held to remain regarding SMI’s capacity to identify any previously undiscovered hazardous materials to which the Plaintiffs alleged they were exposed.

As a result, SMI’s Motion for Summary Judgment was denied.

A copy of the opinion can be downloaded here.

Insurer Must Cover Portions of Arbitration Award

Tred R. Eyerly | Insurance Law Hawaii | August 19, 2019

    The court determined that there was coverage in a construction defect case for portions of an arbitration award. Liberty Surplus Ins. Corp. v. Century Sur. Co., 2019 U.S. DIst. LEXIS 116093 (S.D. Texas July 12, 2019). 

    Descon Construction contracted with the City of Edinburg, Texas, to build a library. Descon subcontracted with McAllen Steel Erectors to install the library metal roof. The roof began to leak within two months of occupancy. The leaks continued for seven years. 

    Edinburg sued Descon. The matter was arbitrated. The arbitration panel found that the library roof was defective, the exterior stucco system was defectively installed and certain work, including fire-caulking, had not been performed. The panel concluded that Descon was liable for breach of contract and breach of warranty. The panel determined that Edinburg was entitled to replacement of the existing roof. Further, McAllen was found to have breached its subcontract with Descon by defectively installing the roof, entitling Descon to recover $762,537 from McAllen. 

    Descon asked Liberty to cover the award, but Liberty refused. Liberty sued the City and McAllen’s insurer, Century, seeking declaratory relief that its policy did not cover the award. Liberty moved for summary judgment. Liberty contended that if it was liable for the award, Century had to pay under its policy with McAllen, which named Descon as an additional insured. The City cross-moved for summary judgment arguing that some of the award damages were covered and no exclusion applied. Century also cross-moved for summary judgment that its policy did not apply.

    The parties agreed that defective roof and exterior stucco installations were “occurrences” under the policies. The question was whether Liberty’s policy covered only: (1) “property damage” caused by the defective roof and stucco, as Liberty and Century argued; or whether the policy covered both (1) “property damage” caused by the defective roof and stucco and (2) the costs of repairing the roof and stucco, as the City argued. 

   Liberty and Century argued that defective work in and of itself was not “property  damage” under Texas law. Because the City sought coverage for the cost of fixing defective work, Liberty’s policy did not cover any arbitration award damages. The City responded that the cost of repairing faulty workmanship was covered if the faulty workmanship resulted in “physical injury” to “tangible property.” The City argued that the defective roof caused interior water damage and Liberty had to cover the award damages for the roof and stucco repair costs. The City also pointed out that the library would continue to sustain water damage until the roof was replaced. Therefore, Texas law required Liberty to pay for the roof replacement costs.         

    The arbitrators found that the library roof and stucco were themselves defective, not that they were damaged or unusable because of other defective work. The court ruled that Liberty’s policies covered the cost of repairing the ceiling tiles, as Liberty conceded, and not the costs associated with repairing or replacing the stucco or the roof. 

    Liberty’s motion was granted to the extent that Liberty was not liable for the stucco or roof replacement costs. The motion was denied, without prejudice, as to Liberty’s liability for ceiling tile damages. The City’s motion was denied on coverage because the policy covered only the ceiling tile damages. Century’s motion was denied as moot. 

Insurer Must Pay Portions of Arbitration Award Related to Faulty Workmanship

Tred R. Eyerly | Insurance Law Hawaii | August 21, 2019

    The court determined that portions of an arbitration award against the insured contractor based upon faulty workmanship were covered by the policy. Wallace v. Nautilus Ins. Co., 2019 U.S. Dist. LEXIS 122219 (D. N. H. July 23, 2010). 

    Plaintiffs, owners of adjoining homes, hired McPhail Roofing, LLC to replace the roofs of their houses. After installation, the plaintiffs found several problems with their roofs and withheld roughly a third of the agreed-upon contract price from final payments due to McPhail. A roofing consultant found evidence of water leaking through both roofs during rainstorms. Improper installation of the shakes on the roofs allowed rain to seep through to the roof decks (the plywood underneath the roofs) and eventually into the houses. The only way to cure the installation defects was to remove and replace the roofs entirely. 

    Plaintiffs and McPhail went to arbitration. Plaintiffs sought compensation for the damage caused by the leaking and for the replacement costs of the roofs. McPhail sought the remaining payment under the contracts. Nautilus defended McPhail under this CGL policy. 

    The arbitrator issued awards against McPhail, $140,053.50 to one owner and $160,065.62 to the other owner. Pursuant to the parties’ stipulation, the arbitrator also awarded plaintiffs $176,898.95 for attorneys’ fees, expert witness fees and other expenses, including pre- and post- judgment interest.

    Nautilus paid a portion of the award for attic cleaning and re-insulation, repainting, expert witness fees and expenses. Nautilus determined the rest of the award, including replacing the roofs and award of attorneys’ fees, was not covered under the policy. McPhail declared bankruptcy and plaintiffs obtained an assignment of McPhail’s claims against Nautilus, eventually bringing suit against Nautilus. 

    Agreeing that defective workmanship alone was not an occurrence under New Hampshire law, plaintiffs argued that the occurrence here was not the defective workmanship itself, but rather the leaking caused by the defective roofs, which resulted in property damage. The court agreed.

    The damage for the cost of replacing the roofs was not covered, however. The arbitrator found that plaintiffs were entitled to the replacement cost of the roofs because: (1) the roofs were installed defectively; and (2) plaintiffs’ consultant advised them that the only way to cure the installation defects was to remove and replace the roofs. No New Hampshire case held that a CGL policy covered the cost of replacing defective work any time property damage resulted from it. 

    Next, the court turned to whether the policy covered the award of attorneys’ fees. The Supplementary Payments provision included Nautilus’ obligation to pay “costs taxed against the insured.” Plaintiffs argued the phrase was ambiguous and should be construed in their favor. The court noted that several jurisdictions had interpreted the phrase to include an award of attorneys’ fees, but noted that a Hawaii federal district court case held that the phrase excluded attorneys’ fees. CIM Ins. Corp. v. Masamitsu, 74 F. Supp. 2d 975 (D. Haw. 1999). The court went the the majority position, finding that “costs taxed against the insured” in the Supplementary Payments provision included attorneys fees.