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.

Can My Recovery be Limited to Actual Cash Value When the Insurer’s Failure to Pay Prevented Compliance with My Policy Condition on Recovering Replacement Cost?

Paul LaSalle | Property Insurance Coverage Law Blog | March 12, 2019

Insurers often try to limit damages once they are found liable for breach of the insurance contract by claiming that the insurance policy limits the insured’s recovery to the actual cash value because the insured did not comply with the policy’s condition on recovering replacement cost.1

Insureds generally counter by arguing it would be inequitable for an insurer to withhold payment of actual cash value because of alleged non-coverage under the policy (making it impossible or at least difficult for the insured to replace the damaged property without funds from the insurer), and later deny replacement cost payment when found liable for coverage because the insured did not comply with the policy condition on recovering replacement cost.

In a recent case,2 a federal court addressed this scenario and predicted3 that under Pennsylvania state law an insured could recover replacement cost despite noncompliance with a policy’s replacement requirement condition where the insurer’s denial of liability and failure to pay actual cash value prevents the insured from replacing the property. The court further ruled that the insured must still demonstrate that, but for the insurer’s denial of actual cash value payment, they would have replaced the property. Consequently, an insured may not be able to recover replacement cost if it is shown they had no intention of replacing the damaged property.

In utilizing the “prevention theory” to approach replacement requirement conditions in insurance policies, the inquiry focuses on the insurer’s actions and their consequences for the insured’s ability to perform—whether the insurer paid actual cash value or denied liability altogether and whether denying funds made it impossible, or at least unduly risky, for the insured to comply with the replacement requirement condition. Thus, the replacement requirement condition will be excused (and the insured may recover replacement cost) where the insurer’s denial of liability and failure to pay actual cash value prevents the insured from replacing the damaged property. A replacement requirement condition may not be excused, however, where the insurer has admitted liability and has made payment for the actual cash value, but the insured could not hire a contractor to rebuild because the parties disagreed on the proper value of the damaged property.
1 The following is an example of an insurance policy’s condition on recovering replacement cost:
We will not pay on a replacement cost basis or any “loss”:
(1) Until the lost or damaged property is actually repaired or replaced with other property of generally the same construction and used for the same purpose as the lost or damaged property; and
(2) Unless the repairs or replacement have been completed or at least underway within 2 years following the date of “loss.”
2 Utica Mutual Ins. Co. v. Cincinnati Ins. Co., 2019 WL 290162 (E.D. Pa. January 23, 2019).
3 Under the Erie Doctrine, a federal court hearing a state law claim must apply state substantive law to resolve the claim. When a state’s highest court (in this case, the Pennsylvania Supreme Court) has yet to speak on a particular issue, a federal court deciding the matter and applying the state’s substantive law must predict how the state’s highest court would decide if confronted with the issue. This is commonly referred to as an Erie Guess.

Insuring to Value: Replacement Cost vs Reconstruction Cost

Chip Merlin | Property Insurance Coverage Law Blog | June 23, 2017

A recent post, Insurance Agents and Determining Coverage Limits for Buildings, generated a number of very interesting comments about the differences between Replacement Cost Value of a building and the Reconstruction Value of a building. There is a difference between the two values and it is a big issue.

A.W. Hooker posted an article soliciting it services, Replacement or Reconstruction Cost Estimate, which discusses the difference and explains the significance of insuring to value and obtaining coverages which reflect reconstruction costs rather than replacement cost values when deciding on policy limits and coverages for structures:


How do insurance companies calculate the replacement cost?

There is no standard method used by insurance companies but most often a construction cost manual such as Marshall & Swift will be referenced for the unit cost per square foot of a similar type of building and multiplied by the area of the subject building.

Why is this a flawed way of calculating the replacement cost?

Because it is theoretical replacement with a similar type of building and not an actual reconstruction cost evaluation, which includes for all costs associated with reconstructing a building at today’s standards and codes. Other costs are not considered with replacement cost, such as demolition of the existing destroyed building. While replacement cost is merely the cost to replace the building using the same as or far as possible the same material and design as what exists.

When is a replacement cost appropriate, when is a reconstruction cost appropriate?

For many simple or standard types of buildings the replacement cost taken from a cost manual may be appropriate. However if there is any non-typical or unique characteristics to the property it will likely not be appropriate. For any special purpose property or special use property only a detailed reconstruction cost estimate prepared by a Quantity Surveyor will properly account for all the unique characteristics present.

In many cases, the replacement cost calculated from the ‘black book’ value will not be enough to cover the costs to rebuild the property. Should a loss occur, the owner would be out of pocket for rebuilding expenses over and above the ‘black book’ value. It is recommended that in all cases, a reconstruction cost estimate be used, particularly when the property is used for commercial purposes.

What sort of rebuilding expenses are not taken into consideration from the ‘black book’ value?

Demolition and clearance of the site, shoring up of neighbouring buildings, reinstatement of any non-structure components of the site (such as a parking lot, landscaping or below grade services) allowance for the escalation of the cost of labour and materials in the future, permit fees, and any premiums associated with construction for the property’s geographic area.

The ‘black book’ value also does not take into consideration that should your property need to be rebuilt, it would have to be built to be compliant with the current building code, which could have a serious impact on the design and materials you must use to rebuild. A Replacement Cost Estimate will only cover the cost to replace the building with one of comparable size, utility and materials. For example, it would not take into account that your new building will require an elevator (where a narrow staircase previously sufficed).

What are the other considerations that will be taken into account for a Reconstruction Estimate?

Heritage components, current building codes, construction standards, accessibility, building material availability, etc,

The Massachusetts Association of Insurance Agents held a seminar on the topic. The PowerPoint presentation, Replacement Cost v Reconstruction Cost v. Total Component Valuations: Is the Client Covered Effectively? provides an excellent discussion of policy coverage terms causing gaps in coverage. The author noted that the primary problem for the agent is found in the rules to determine valuations, policy limits, and policy language. The presentation warns through numerous examples that replacement cost values may leave the policyholder with significant out of pocket expenses.

The problems of properly insuring a structure with values that do not leave the policyholder with gaps of coverage and for limits sufficient to reconstruct are complex. I find it amusing that judges, not trained in the nuisances of insurance, write so many opinions that the policyholder is in the best position to make this analysis. Really? If agents cannot even figure out which values to use and have to be taught to understand the potential gaps of coverage, how can a uneducated consumer be in a better position?

Does Actual Cash Value Mean Fair Market Value or Replacement Cost minus Depreciation?

Kevin Pollack | Property Insurance Coverage Law Blog | June 4, 2017

What is an insured, who has an “actual cash value” property insurance policy, entitled to recover when their property is damaged, but not a total loss? Is the insured entitled to the cost to repair/replace the property minus depreciation? Or is the insured’s recovery limited to the property’s fair market value? What if the property’s fair market value of the property at the time of the loss is far less than the amount of money it will take to repair the property minus depreciation?

The California Court of Appeal, recently dealt with these issues in California Fair Plan Association v. Garnes.1 In Garnes, the insured’s home was damaged by a kitchen fire. At the time of the loss, the property was insured by California Fair Plan on an actual cash value basis, had a policy limit of $425,000, and had a fair market value of only $75,000.

The California Fair Plan insurance policy contained a paragraph entitled “Loss Settlement,” which stated that Fair Plan would pay the following amounts for losses to the insured’s dwelling:

(1) Total Loss: If the greater of the cost either to reconstruct or replace the damaged part of the property exceeds the actual cash value before the loss of all covered property …, we will pay such actual cash value.

(2) Partial Loss: In the cases of losses that are not described in (1) above, we will pay the least of the following amounts: [¶] (a) The lower of the cost either to reconstruct or replace the damaged part of the property, less a reasonable amount for depreciation; or [¶] (b) The actual cash value before the loss of the damaged property.

The policy defined “actual cash value” of property to mean “its fair market value.”

The insured argued that she should be able to recover the amount it would cost to repair the house, less an amount for depreciation, the net amount of which was agreed to be $320,549. California Fair Plan disagreed and argued that the insurance policy and the California Insurance Code allowed it to pay the lesser of that amount or the fair market value of the house, which at the time of the fire was $75,000. California Fair Plan argued the loss was a “total loss” because the cost to repair the property exceeded its fair market value. The insured, however wished to rebuild the property because it had not been destroyed and based on its sentimental value to her family.

The trial court agreed with California Fair Plan and granted its summary judgment motion, finding California Fair Plan needed to only pay $75,000—the fair market value of the property at the time of the loss.

The insured appealed.

The court of appeal first examined Insurance Code section 2051:

Section 2051 sets forth the “measure of indemnity in fire insurance” for an open ACV policy…. In the case of a “total loss to the structure,” recovery is limited to the lesser of the policy limit or a property’s “fair market value.” (§ 2051, subd. (b)(1).) In the case of “partial loss to the structure,” however, recovery is not limited to fair market value; instead, it is the lesser of the policy limit or “the amount it would cost the insured to repair, rebuild, or replace the thing lost or injured less a fair and reasonable deduction for physical depreciation based upon its conditions at the time of the injury.” (§ 2051, subd. (b)(1).) Under subdivision (b)(2), it is clear that in the case of “partial loss to the structure,” the insured is entitled to repair, rebuild or replace that which was lost or injured. While such recovery is reduced by a deduction for physical depreciation and may not exceed the policy limit, nothing in subdivision (b)(2) or the remainder of section 2051 indicates that the policyholder is limited to the fair market value of the property or any part of it.

(Emphasis added.)

Based on the language of the statute and the fact that the insured’s property was not totally destroyed, the appellate court concluded that the insured’s claim was for a “partial loss to the structure” (not a total loss) and that, under Insurance Code section 2051, she was therefore entitled to recover the amount it would cost her to repair, rebuild, or replace the damaged property less a fair and reasonable deduction for physical depreciation based upon its conditions at the time of the injury.

California Fair Plan then argued, that despite the Insurance Code’s language, its policy, not the insurance code, controlled the outcome, and because its policy defined actual cash value as fair market value, and because its policy gives the insurer the option to pay the lesser of the amount to repair the property minus depreciation or the fair market value, it was only required to pay the insured $75,000.

The court disagreed, and held that where an insurance policy’s terms violate the insurance code, the insurance code controls. Its rationale on this issue was:

The parties also dispute whether the Policy is to be applied in accordance with its terms or instead in accordance with the Insurance Code. FAIR argues that regardless of whether the Policy complies with the governing Insurance Code provisions, this case and its obligations to Garnes are “governed by the policy she purchased, not by some statutory form policy she never purchased.” Garnes relies on Century–National Ins. Co. v. Garcia (2011) 51 Cal.4th 564, 120 Cal.Rptr.3d 541, 246 P.3d 621 (Century–National) for the proposition that “a fire insurance policy that offers less coverage than the standard form (Insurance Code § 2071) is invalid,” and “that insurers may not provide less coverage than appears in the form fire policy set forth in § 2071.”

[W]here California’s statutory or decisional law require coverage, an insurer may not circumvent the law by employing contrary contract terms…[W]here an insurer’s policy contains terms that conflict with the law, the courts will decline to enforce the impermissible terms and read into the policy the terms required by statute.

The court ruled that “since mandatory insurance coverage provisions are incorporated into every policy to which they pertain, section 2051 is incorporated into the standard form policy set forth in section 2071, as indicated by case law, regulation and statute.”

Consequently, the court determined that California Fair Plan’s provisions seeking to limit an insured’s recovery for a partial loss to a structure to the property’s fair market value was unenforceable because such provisions were in direct conflict with Insurance Code section 2051.
1 California Fair Plan Ass’n v. Garnes, No. A143190, 2017 WL 2303165 (Cal. Ct. App. May 26, 2017).

Essential Property Insurance Coverage Information Withheld from Consumers

Nicole Vinson | Property Insurance Coverage Law Blog | April 23, 2017

An April 2017 report by United Policyholders reveals the state rankings of homeowner insurance protections that impact buying insurance. The research revealed that many major insurance companies and many states withhold coverage and policy provisions from consumers during the purchase. These same companies and states also withhold payment information.

No states were awarded the five-star ranking.

Florida and California earned three-star rankings with New York and New Jersey hitting the two-star level. The report measured just how well states themselves provide information to consumers and how their laws mandate insurance companies to disclose and provide to the public consumer.

Jay Feinman, the author of Delay, Deny, Defend, of Rutgers Law and the co-director of the Rutger Center for Risk and Responsibility at Rutgers Law School sent over the report. Looking nationwide at homeowners insurance, Coverage, Quality, and Price are all important when buying insurance no matter the state. Homeowners need to have more information when purchasing or renewing insurance. The report notes that disclosure will create more competition between the companies resulting in better products and a fairer price.

After a loss, many policyholders hold on to their one key understanding of their policy: “I remember I bought a replacement cost policy.” Many policyholders are impressed with the term “replacement cost” before the loss but it is later revealed that after reading and re-reading all the exclusions and limitations there are more issues to deal with before replacement even comes into play. How depreciation factors into a claim matters a whole lot less if the carrier is citing a provision that no coverage is afforded on the claim. This is not to say that the carrier is appropriately applying an exclusion or interpreting the policy in the proper way, but these hurdles of coverage must be addressed before getting to numeric figures.

Here is how the Rutgers report explains and addresses the hidden coverage information:

“Insurance is the only product for which consumers don’t know what they are buying before they buy it.”

This is shocking when you think about it, but true. The quote and the application give us virtually nothing when it comes to the details of the actual policy.

Insurance companies almost never provide copies of policy language or complete summaries of policy terms to prospective policyholders. And what homeowners are buying can vary widely from one insurance company to another, with some major insurance companies providing coverage that offers much less protection than coverage provided in standard homeowner insurance policies.

We deal with this day in and day out in Florida because carriers are sending off new forms for “self-approval” with the Department of Financial Services. Often, it appears the department governing insurance is shocked to learn about how gutted the policy forms have become when you read them in conjunction with the other provisions that are implicated.

The report recommendations for all states are clear and concise:

Insurance departments should post online the homeowner insurance policies of all insurance companies doing business in the state, or at least those companies that have a significant market share.

A step further that is necessary from a practitioner standpoint is that all variations and options of coverage should be highlighted for each company so one can see that not all of an insurance company’s policies are the same. Don’t be fooled just because you have a policy from the same company as your neighbor.

State departments of  insurance should provide a comparison tool that enable consumers to easily compare key terms of insurance policies.

States should require insurance policies to be clearly organized and written in plain language.

Merlin Law Group constantly asks carriers if they understand the policies they have written. Often, claim managers and supervisors admit they aren’t sure or don’t know. Writing a better policy is a simple request but will likely never happen because the apparent desire for carriers to escape indemnity is now the cornerstone of how business is done by many.

Transitioning to another missing portion of the insurance buying process, for “quality,” all consumers have to rely on now is perhaps their own experience in an auto claim (wholly unrelated) and media ads about the service from an insurance company. Wouldn’t you really like to know when push comes to shove how your loss would be handled for various problems? The measure for quality is the financial stability of the company along with their record of paying claims promptly and fairly. That is not too much to ask.

Consumers should be told the average time it takes to pay a claim, the proportion of claims denied, and the number of the policyholders who had to sue the insurance company for payment. The request is for insurance companies to post online information about insurance company practices in paying claims for consumers to view and compare.

Again, it sounds like something that should already be in place in every state, but no state makes claim payment information available to consumers and no state requires the companies to provide clear summaries of policy terms to consumer shopping for insurance.

Want to see how your state stacks up? The report is available here.

The more information a policyholder has about insurance at the time of purchase and at the onset of coverage can only help the industry and consumers. Why is this information so hidden? All signs point to this benefiting the company and its bottom line—to the detriment of policyholders.

For other posts on United Policyholders and their phenomenal work for insureds see:

  • Rutgers Law School and United Policyholders Launch Essential Protections for Policyholders Project
  • United Policyholders Sues FEMA Over Withheld Sandy Claims Documents
  • United Policyholders Continues its Good Work

More on Jay Feinman is posted in:

  • Jay Feinman Interview at First Party Claims Conference
  • New Report from Rutgers Calls Out Insurance Companies and Asks States to Help Policyholders