Risk Management and Insurance for Community Associations
Community Associations Institute (CAI) believes that an effective risk management program can best be achieved if associations and their governing boards work with recognized community association professionals. CAI further believes that a comprehensive association insurance program must focus on meeting a broad range of legal and lender requirements while recognizing that the governing board is the trustee of the owners in insurance matters. This program (collectively, risk management and insurance) requires that risks of loss be fully evaluated and that funding for such loss (whether by commercial insurance or self-insurance) must be completely analyzed.
BACKGROUND
Adopting a comprehensive risk management policy and adopting a policy regarding the purchasing of comprehensive insurance are both vital if a community association is to minimize the adverse consequences of accidental loss; maintain the continuity of the association as a business organization; and assist homeowner members in protecting their most important asset—their homes. Both programs need to be thought of as one program. More detailed information is contained in two books available in the CAI Press bookstore at www.caionline.org/shop: Insurance and Risk Management.
There are six steps to establish a risk management program:
Identify Exposures to Loss: There are four exposures to loss—property, liability, net income, and personnel.
Evaluate the Use of Risk Control and Risk Financing: Risk control may eliminate or minimize losses. Risk financing includes purchasing insurance, funding for deductibles, and self-funding for small losses.
Interrelationship of Risk Control and Risk Financing: Recognition of the important intersection of risk control with risk financing and proceed with an understanding of the importance of evaluating both together.
Implement Risk Control and Risk Financing: This requires the board to work with a range of recognized association professionals—attorney, manager, certified public accountant, and insurance agent.
Monitor and Improve: These five steps need to be periodically evaluated in the same manner that the board reviews its financial and similar operations on a regular basis.
As the program moves from risk management to obtaining insurance, the board and its professionals need to regularly view insurance obligations in the broad context of the insurance requirements that arise from several sources:
Governance Requirements:
. Governing documents, including the declaration, covenants, conditions, and restrictions (CC&Rs) and related guidelines, internal policies, and procedures.
- Requirements that may exist in a land lease or related documents that create vested interests in plans and approvals during the development process.
State Enabling Statutes
Certain Other Local, State, and Federal laws:
- Building ordinances and laws (local).
- Workers’ compensation laws (state).
- Flood insurance (federal) whether as a requirement to ensure mortgage lending or to protect against a possible exposure to loss.
Lender and “Agency” Standards: Compliance with mortgage lender requirements and, if desired, with "Agency" guidelines such as those established by the two primary government-sponsored enterprises (GSEs)—Freddie Mac and Fannie Mae—as well as by the Federal Housing Administration (FHA) and the Department of Veterans Affairs.
Indemnitor/Indemnitee Obligations: Compliance with contracts the association may have entered into as well as any entitlement agreements and regulatory agreements by which the association may be bound.
Good Business Judgment: There may be no specific insurance requirements for a given type of coverage, but, if the association, using the risk management process, determines that certain exposures to loss exist and that those exposures may be funded by insurance, then the board should consider obtaining that insurance.
CAI believes that there are certain fundamental analytical components of a risk management & insurance program:
Determining Values at Risk: This may require obtaining an insurable replacement cost valuation to accurately determine property insurance limits. similarly, it may require obtaining a probable maximum loss (PML) study to determine, where appropriate, earthquake insurance limits. This analytical determination may involve investigating association industry best practices. For fidelity insurance, it may require setting an insurance limit at three months of assessments plus reserve funds unless state law provides for different measures. Also, it may require adding the manager/management company as an insured for both fidelity insurance and directors’ & officers’ liability insurance. Further, this may require minimizing or eliminating the application of coinsurance for property insurance. Insurance is a significant cost to the association; lack of insurance can be a greater cost in the event of an under-insured loss because of incorrect limits.
Special Association Coverage Features: Insurance is subject to pricing cycles and coverage availability cycles, but over time, association insurance professionals (together with the insurers with whom they work) have developed certain special coverage features for various critical insurance policies. These features vary with the type of insurance but include by way of example—the association as the first named insured, noncompensated individuals as eligible for fidelity insurance coverage and a broad named insured for wrongful act protection in a directors’ and officers’ policy. These special features can be best be determined by working with knowledgeable insurance agents and related professionals.
Interface between the Owner and the Association: Often, there is a coverage gap between the insurance obtained by the homeowner and that obtained by the association. This gap may be minimized and possibly eliminated if the association and owners are educated concerning the insurance obligations of each. This requires an understanding of the following:
Who owns (or has legal responsibility) for something.
Who needs to maintain or repair something.
Who needs to replace (or reserve for) something.
Who has to insure something.
These four components need not be linked together, but they need to be understood especially if the units and common elements are to be properly insured.
RECOMMENDATION
Governing boards, working with association professionals, must develop a comprehensive risk management and insurance program to minimize the adverse financial and related consequences of accidental loss and to help protect homeowner investment in their homes. To ensure there is a comprehensive approach, this program should be based on certain risk management principles and anchored in the governance, legal, lender, and related requirements. Further, this program requires analytical efforts for determining values at risk, obtaining special coverage features, and properly allocating risk between the association and the homeowner.
This effort is best done in collaboration with knowledgeable association insurance agents and professionals especially those who have earned the CAI designation of Community Association Insurance & Risk Management Specialist and who have attended the CIRMS Insurance Masters program.
CAI also recommends that:
Risk management and insurance be coordinated with the preparation of the association’s annual budget and reserves.
Risk management be reviewed regularly.
Insurance loss runs annually.
Approved by the Government & Public Affairs Committee on September 20, 2012
Adopted by the Board of Trustees on October 11, 2012