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