Insurance Coverages: Determine The Correct Amount, By Dan Harkey

There are different definitions of value. Market Value refers to the value of the property bought and sold in a competitive marketplace. The legal definition of “market value” is a price at which the seller is willing but not compelled to sell and would accept from a buyer willing but not compelled to buy. Establishing an opinion of value, known in the industry as market value, is measured by comparing the market prices of comparable properties in neighborhoods with similar amenities.

Appraisers, with their expertise in segregating the improvements from the land property value and determining replacement costs, including outbuildings and appurtenances, play a crucial role in determining the amount of insurance. Their application of a depreciation factor and perhaps an economic obsolesce factor results in an overall value, with depreciation and economic obsolesce not considered insurable.

The loan processor and underwriter are crucial in determining the insurable value. They need to segregate the value of the land from the replacement building cost. This is important because the land value component differs with geographic location and desirability, referred to as amenity value. A structure with an ocean, lake, mountain, city, park, or amenity-based frontage may result in a high premium for the land component. The property is assumed to be pleasant, attractive, and agreeable, which results in greater demand. However, the structure replacement cost may be the same regardless of land value.

It's crucial to note that the amount of insurance is not always required to cover your loan. If the loan is greater than the replacement cost of the building, then the land is most likely more significant as an allocated portion of the overall value. This underscores the importance of discussing the amount of insurance with the borrower and Insurance agent/broker to determine what is correct, making the agent an active participant and the borrower a responsible party.

Although liability insurance is not required, I recommend that the borrower have coverage for at least one million dollars. This will be part of the policy if the property is a commercial structure, such as a rental or leased-fee retail store. If the property is a residential structure, in most cases, the liability portion of the coverage is an insurance rider referred to as an umbrella policy.

Employing third-party vendors is an essential component of transactional success. Among these, full-line insurance brokers stand out as among the most valuable; their knowledge of various coverages and the overall insurance marketplace is paramount, providing you with a sense of reassurance and security.

Depending on property type and usage, additional types of insurance coverage will be required. For instance, a commercial property may need coverage for loss of rent or business interruption, while a residential property may require coverage for personal liability. The tenants must have separate insurance policies naming the property an additional insured. These coverages may be contained in the primary insurance policy or by special endorsements, providing a comprehensive and secure coverage plan.

Here are a few questions to answer:

1.     Who is/are the primary insured parties?

2.     Are there secondary or additional insured parties, such as the lender?

3.     Are there 3rd party insurance considerations, such as insurance that property owners require of tenants or lessees covering various losses and liabilities, that are not or should not be the property owner's responsibility?

Additional types of insurance are needed to cover furniture, fixtures, and equipment, loss of rent, business interruption, employee theft, workers' compensation, loss of intellectual property, and use of an employee or vendor vehicle not belonging to the insured party. The property owner also wants a workers' compensation policy for casual or temporary contractors without insurance.

It is essential to use a lender loss payee endorsement, usually the 438 BFU form, and understand the mortgage clauses. Remember that the insured party in a mortgage clause will be the lender rather than the borrower.

Dan Harkey

Business and Private Money Finance Consultant

949 533 8315 dan@danharkey.com

Visit www.danharkey.com