Condo Association Insurance 101 - Knowledge for Board Members

This article provides an overview of the types of insurance that an Association should and must maintain. The Board of Directors is responsible for ensuring that the legal and reasonable levels of insurance coverages are in place at all times to protect the members of the Association. This is a great responsibility and should not be taken lightly.

A Warning of Importance

As I instruct my staff on a regular basis, in the governance of an Association there is nothing that carries a higher risk of legal liability than matters of insurance. The potential cost associated with errors in this area are multiples higher than any other matter that a Board will likely ever face.

Today’s condominium and community associations are confronted with a wide range of disputes and issues that can lead to costly litigation for an association. These issues range from disputes between unit owners, disputes over responsibility for repairs within individual units, as well as large and complex issues where law suits occur, such as construction defect issues, contract claims and non-property damage claims, such as discrimination claims.

It is inevitable that at some point your Association will either be sued or have a property-related loss caused by weather or other factors. When these situations occur it is the Association’s insurance policies that will likely be used to protect the Board and property. This assumes, however, that the appropriate types and levels of insurance are in place. If not, the Board member and Association are on their own. To make matters worse, if the proper types of insurance are not in place when such a loss occurs, the Board members may be sued personally by the ownership for negligence and similar claims.

Rules Governing your Association

To understand the types and amounts of insurance that your Association must maintain, it helps to understand the levels of governance, or rules that control your Association. First and foremost, all Associations within the State of Illinois are subject to the rules and laws contained within the Illinois Condominium Property Act. This is the “master” set of laws and will always supersede any conflicting rules that may be contained in your Association’s governing documents.

Outside of the state laws, all condominium associations will have at least two governing documents. Each is important and will exist for all associations. These two governing documents are:

1. Declaration Document – This document provides the legal description of the association. Users will most often refer to the declaration document for two primary reasons:
   1. To determine how portions of the property and building are defined; common elements, limited common elements or components of the unit.
   2. To find the percentage of ownership assigned to each unit.
2. Bylaws – All associations will also have Bylaws, which provide a high level set of guidelines that define how the association should function. For example, the Bylaws will provide the list of duties that the Board should perform and commonly the levels of insurance that all parties must maintain.

Note: In some cases the Declaration and Bylaws will be contained within the same document. Both, however, are technically separate items and all associations will have both.

While the Declaration and Bylaws may contain “rules”, these are structural guidelines primarily related to defining how the Board should function and how the association should be supported. Neither of these documents will contain traditional rules related to living at the property, aka the building’s day-to-day living rules. The Illinois Condominium Property Act allows Boards to implement an additional, or third, governing document to work in conjunction with the Declaration and Bylaws. This optional governing document is called Rules & Regulations.

The Order of Importance

Condominium Associations in Illinois are bound by the following list of governing documents or laws, listed in the order of importance and enforceability:

1. Illinois Condominium Property Act
2. Declaration & Bylaws
3. Rules & Regulations (Optional)

A lower level document may not conflict or contradict a higher level document. For example, if your Bylaws require that the Board hold four (4) meetings each year, a Board may not create a rule to the contrary in the Rules & Regulations since the document is subservient to the Bylaws.

The Illinois Condominium Property Act changes regularly

Unlike your Association’s declaration and bylaws, the ICPA changes on a regular basis, often annually. New laws are passed and edits and updates are made. Since the ICPA is the “master” set of rules, changes immediately supersede any conflicting language that may exist in your Association’s governing documents.

The good news is that the law does not require your Association’s governing documents to be kept up-to-date and in-line with the language of the ICPA. Any conflicting language in your Association’s governing documents simply becomes invalid and unenforceable. Meaning, the Board must simply ignore any parts that conflict with the ICPA. The remainder of the governing document, however, remains in full effect.

How to Determine the Types of Insurance Required

The types of policies that your Association is required to maintain, and the associated policy limits, are set by a blending of the Illinois Condominium Property Act and your Association’s governing documents. The ICPA sets baselines for the types of coverage that all condo associations in Illinois must carry, but an individual Association’s governing documents may have additional requirements.

Note: Sections 12 and 12.1 of the Illinois Condominium Property Act set forth the insurance requirements for all condominiums throughout the state. http://www.ilga.gov/legislation/ilcs/ilcs3.asp?ActID=2200&ChapterID=62

As this document reviews the types of insurance required, it is assumed that your individual Association may require additional types or levels of insurance. Some of the common “extra” types of policies found in many governing documents are details towards the end of this document.

Note: If you live in a townhome association, the Board must look solely to the Association’s governing documents for the required types and levels of coverage required. Please note that these are minimums and your Board may need additional types of insurance to properly protect the Association. (Workers’ Compensation Insurance, for example)

Association Insurance vs. Unit Owner Insurance

There is an important distinction between the insurance that the Association must provide (and the areas of the property that this insurance protects) versus the insurance that should be maintained by the individual unit owners. There is often confusion related to these matters, and unfortunately, many owners that falsely believe that they do not need to purchase insurance to protect their individual unit.

As stated earlier, determining the levels of insurance coverage required by the individual unit owners requires a review of the Association’s governing documents. Strictly from the perspective of the Illinois Condominium Property Act, the Association’s board must obtain property insurance on the common elements and the units, including the limited common elements, covering at least the bare walls, floors and ceilings of the unit. 

This property insurance need not cover “improvements and betterments” to the units installed by the unit owners, but if the board decides to take on insurance to cover the improvements and betterments, any increased cost to the association may be assessed back to those unit owners who have constructed the improvements or betterments. Improvements or betterments are now defined in the Illinois Condominium Property Act as: “All decorating, fixtures, furnishings, including electrical fixtures, appliances, air conditioning and heating equipment, water heaters, or built-in cabinets installed by unit owners.”

Note that the owner’s belongings are never covered by the Association’s policy. In practice, most Association policies cover only the bare walls, floors and ceilings of the units. Everything else, is the responsibility of the unit owner to insure. This includes all of the owner’s personal belongings.

HO-06: A Condo Owner’s Policy

There is a specific classification of insurance policy that is obtained by condo owners. The policy is unique since the “shell” of the unit is insured by the Association. Typically everything within the unit, certainly all of the owner’s personal belongings, are never covered by the Association’s policy.

The owner must obtain an HO-06 type policy to protect against personal property losses and liability. Unfortunately, some owners believe that should a fire or flood occur, for example, their personal belongings will be replaced by the Association’s insurance. This is not the case and will never occur.
There are also liability-related risks that a unit owner must consider. For example, if an owner’s guest injures themselves while inside of the owner’s unit, there could be a law suit. If the owner does not have liability insurance, the cost of the legal defense and any ultimate money judgments or awards must be paid for by the unit owner.

Are Owners Legally Required to Obtain Insurance?

The same answer applies here as with many insurance-related questions: you must review the Association’s governing documents. The Illinois Condominium Property Act does not require a unit owner to purchase insurance to protect their unit. The ICPA does, however, allow the Board to require unit owners to maintain insurance through a requirement in the declaration document, bylaws or rules & regulations.

The ICPA provides that the Board of Directors may adopt rules that require owners to obtain insurance covering their personal liability and compensatory damages to another unit caused by the negligence of the owner or his or her guests, residents or invitees, regardless of any negligence originating from the unit.

The key is that the Board must make sure that rules existing within their governing documents that require owners to obtain insurance.

How can our Board enforce Owner-Insurance rules?

One recent change to the Illinois Condominium Property act in 2015 is that the following language from the act has been removed:

If the unit owner does not purchase or produce evidence of insurance requested by the board, the directors may purchase the insurance coverage and charge the premium cost back to the unit owner. In no event is the board liable to any person either with regard to its decision not to purchase the insurance, or with regard to the timing of its purchase of the insurance or the amounts or types of coverages obtained.

This remedy was not practical since it is nearly impossible to find a carrier willing to provide a policy to cover someone else’s property. Meaning, Boards were not able to actually obtain insurance on the owner’s unit. Assuming that the Association has a requirement in their governing documents requiring unit owners to maintain insurance, the Board can work with an attorney to file suit against any owner that fails to comply.

The Basics of Insurance

There are some fundamentals of all insurance policies that should be understood by Board members. This will greatly assist in evaluating options and understanding how to use your insurance coverages properly.

Insurance is not a warrantee policy

(This section is specific to a “property” policy) Many Board members confuse the Association’s insurance policy with some type of maintenance program that pays to repair areas of the building that get old and need to be maintained or repaired. This is not the case.

There are many things that aren't covered under an Association’s property policy, including those situations typically resulting from neglect and a failure to properly maintain the property. Termites and insect damage, bird or rodent damage, rust, rot, mold, and general wear and tear are generally not covered.

If something was poorly made or has a hidden defect, such as a poor job done by your developer, this won't be covered. The same applies to any mechanical breakdowns.

Policy Limits

Every insurance policy has a “limit”. This is the maximum payout that the policy will allow should one or more claims occur. As you might suspect, the higher the policy limit, the more expensive the insurance policy will be.

When comparing different insurance options, it is critical to compare the policy limits since that is the amount of protection the policy is providing. For example, a policy with a coverage limit of $100,000 is not worth nearly as much as a policy with a coverage limit of $500,000. It should come as no surprise that the $500,000 policy is going to be more expensive to purchase.

Also understand that if a situation occurs where the actual damages are in excess of your insurance policy limit, the remainder must be paid by the Association. For example, let’s assume we have a property policy with a limit of $1M protecting our Association. If a fire occurs and the entire building needs to be rebuilt, costing $5M, the Association is in deep trouble. The Association will receive $1M from the insurance company, but will be remaining $4M required to rebuild the property will be the responsibility of the unit owners.

It is due to these situations that the State of Illinois has set minimum policy limits into the law so that these types of “under-insured” situations are less likely to happen. Any such legal minimum limits are listed below with each policy type that is discussed.

Deductibles

The deductible is another key factor in an insurance policy that must be evaluated when comparing policies. The deductible is the amount of expenses that must be paid out of pocket by the Association before an insurance company will pay any expenses.

For example, let’s assume that the Association’s deductible on its property policy is $5,000. This means that if an insurable loss occurs, such as a flood or fire, the insurance company requires the Association to pay for the first $5,000 of damages before the policy will provide coverage.

Using that same example, let’s assume that a fire occurred that caused $25,000 of property damage. Since the policy’s deductible is $5,000, the insurance company will only pay $20,000 towards the damages. (The first $5,000 being the responsibility of the Association)

In a second example, let’s assume that a fire occurred that only caused $4,000 in property damage. In such a situation, the insurance company will not pay anything towards the damages since the total is less than the deductible, $5,000.

The lower the deductible, the more valuable the insurance policy should a loss occur. Of course, the lower the deductible, the more expensive the policy will be from the insurance company. When shopping for insurance, the Board must find a balance between a reasonable deductible and the cost of the policy.

Exclusions

Exclusions are also important to understand since they are often discovered by the Association far too late, after a loss has occurred. An exclusion is a situation or event that is not covered under the terms of the insurance policy.

For example, an insurance policy may have an exclusion for floods. If such an exclusion existed, and your property flooded, the insurance policy would not provide any protection. A Board does not want to find out about this type of exclusion AFTER the flood occurs since it is too late.

All insurance policies have exclusions since they do not provide coverage for every situation, and as detailed earlier, they are not a warrantee program. It is important, however, to review any common exclusions with the insurance broker to make sure that the Association has protection against all of the types of risks needed. This is especially true for Directors & Officers insurance, which is reviewed in a later section of this document.

Special Endorsements

A special endorsement is the opposite of a policy exclusion.  If an Association finds that the core insurance policy contains an exclusion (does not provide coverage) for a certain type of event, such as a flood or earthquake, the insurance company may sell a special endorsement, which provides coverage for a specific type of loss.

Part of the reason why it is so important to understand what types of exclusions may apply in a policy is so the Board can ensure that special endorsements are purchased, if needed, to provide protection against certain types of losses.

For example, most condo owner policies (known as a HO-06 policy) have an exclusion for sewage backups. Meaning, should a sewage backup occur at the Association, any damage to the unit would not be covered by the owner’s HO-06 policy. For an owner of a basement or garden level unit, this is a serious issue since sewage backups regularly cause damage to these types of units. Most owners of garden-level units do not learn that such an exclusion exists in their policy until after a sewage backup occurs and their unit has been damaged. The owner must pay for a special endorsement in these situations to provide protection against damage caused by a sewage backup.

Subgrogation

Subrogation refers to an insurance company seeking reimbursement from the person or entity legally responsible for an accident or loss after the insurer has paid out money on behalf of its insured. Stated more simply, an insurance company may pay their customer for a claim that was submitted, but that same insurance company may then try to go after a different entity (most often a different insurance carrier) to be reimbursed. This could include any money paid out for property damage, deductible amounts, pain and suffering, etc.  Subrogation is typically done behind the scenes and without much effort from the insured party.

Let’s use an example to illustrate how subrogation may work. Let’s assume that a fire was started, on purpose, by a unit owner in the hallway of your Association resulting in $20,000 of damage to the common elements. The Association’s insurance company would step in and pay to have the common areas fixed. From the Association’s perspective, the matter is essentially closed.

The Association’s insurance carrier, however, will likely “go after” the owner or the owner’s insurance, since the damage was caused by arson. The insurance company will attempt to subrogate and recoup the costs from the true at-fault party. The Board or Association has no control over the insurance company’s decision whether or not to pursue subrogation. All of these matters are in the fine print of your insurance policy.

Timing of Losses & the Responsible Insurance Carrier

Association Board members are free to change insurance carriers at any time, typically with no penalties. Once you part ways with an insurance company, you do not lose the protection that you paid for. The insurance company responsible for covering a claim is the policy that was in place at the time that the loss occurred.

This means that even if the Board recently changed from State Farm to Travelers, for example, State Farm is still required to provide complete insurance coverage for any incidents that occurred while the State Farm policy was active. In some situations, more often with Liability and D&O types of policies, a claim will not be submitted for months or years after the actual event took place.

For example, the Board may not find out about a law suit against the Association for an alleged slip-and-fall type situation for months or years after the alleged event took place. The insurance company that will be required to pay for the Association’s defense and any resulting settlements is the carrier of the policy that was in place at the time of the alleged event.

Double-Coverage Issues – Association vs Owner

There are situations, especially with property policies, when both the Association and unit owner have insurance policies that protect the same area of the building. For example, the Association is required to have property insurance that covers all limited common elements, such as the front door of a unit. The unit owner’s person HO-06 policy may also provide coverage for the front door. If the front door is damaged in a fire, which insurance policy should be used?

The Illinois Condominium Property Act has solved these types of dilemmas for us by stating that the Association’s policy must always be used as the primary policy. The unit owner’s insurance would then serve as back-up protection. (See ICPA section 12(f))

Types of Insurance Legally Required

These next sections will quickly review the minimum types and levels of insurance that the Board must procure and maintain according to the Illinois Condominium Property Act. As stated numerous times, you must also review your governing documents to determine if further requirements exist. The Board may also determine that increased levels (limits) of insurance are needed, above the legal minimums, or that additional types of policies are needed.

If you are a Board member of a townhome association, you will look solely to your governing documents for your insurance requirements. The types of policies discussed in the following sections will function nearly the same, assuming they are required or wanted by the Board.

Property Insurance

Property Insurance covers damage to the Association’s property caused by such perils as fire, windstorms, hail, lightning, theft or vandalism. Typically, damage to the property caused by floods and earthquakes are not covered unless special “endorsements” are purchased.

According to the ICPA, the board must obtain property insurance on the common elements and the units, including the limited common elements, covering at least the bare walls, floors and ceilings of the units. This property insurance need not cover improvements and betterments to the units installed by the unit owners.

Effective on 6/1/15, Section 12(a)(1) of the ICPA requires associations to carry property insurance for the full insurable replacement cost of the property, less deductibles, plus increased costs of construction due to building code requirements. In order to provide money with which to demolish some or all of a damaged building, the total amount of the association’s property insurance coverage must also include demolition costs and increased construction cost coverage in an amount which is not less than 10% of the insured building’s value or $500,000, whichever is less.

Note: Most often, Property Insurance and General Liability Insurance (discussed next) are provided in a single policy by the same carrier.

General Liability Insurance

Liability insurance is designed to respond to claims related to bodily injury or property damage. This includes bodily injury claims (IE slip-and-fall cases) including pain and suffering, sickness or disease, or death related to the Association. Much of the value in this type of insurance is the legal defense provided by the insurance carrier.

Per the ICPA, all condominium associations must have general liability insurance against claims and liabilities in a minimum amount of $1 million or a greater amount to be determined by the Board. This insurance must insure the Board, the Association, the management agent and their respective employees.

Note: Most often, the Property Insurance and General Liability Insurance are provided in a single policy by the same carrier.

Fidelity Insurance/Bond

Fidelity insurance provides protection against employee dishonesty that results in a loss of funds. From the Association’s standpoint this means any event that ends in the theft of the Association’s funds. The Illinois Condominium Property Act requires the following:

“An association with 6 or more dwelling units must obtain and maintain a fidelity bond covering persons, including the managing agent and its employees who control or disburse funds of the association, for the maximum amount of coverage available to protect funds in the custody or control of the association, plus the association reserve fund.”

There is also a requirement placed on all condo management companies, such as Connected Management, to carry our own, separate fidelity bond. (Which we do) The language in the Illinois Condominium Property Act is:

“All management companies that are responsible for the funds held or administered by the association must be covered by a fidelity bond for the maximum amount of coverage available to protect those funds. The association has standing to make a loss claim against the bond of the managing agent as a party covered under the bond.”

Note: The required fidelity coverage may be bundled together with the Association’s standard Property/Liability policy, or it may be provided through a completely separate carrier. 

Directors and Officers Insurance (D&O)

Directors and Officers insurance protects Board members from damages resulting from allegations of wrongful conduct and lawsuits. It provides legal defense coverage as well as indemnification of damages, up to the policy limits.

This insurance is designed to fill the coverage gaps of the General Liability policy. The General Liability policy is designed to respond to claims related to bodily injury or property damage. Directors and Officers policies respond to claims relating to wrongful acts by the Board. Claims for wrongful acts generally relate to monetary loss without bodily injury or property damage.