A discussion about reserve funds and increased insurance coverage
Q: You recently wrote a column about condominium building’s reserve funds. You failed to mention that condo special assessments are an insurable risk. I just increased my coverage from a limit of $1,000 to $50,000 for an extra $10 per year. You should mention this to your readers.
A: Thanks for bringing this up. You are correct that homeowners insurance companies can issue an endorsement to a condominium policy designed to protect the homeowner from certain special assessments. What you might not realize, however, is that this coverage relates to perils that might not be covered by the condominium’s insurance policy that then result in a special assessment to the homeowners; not all special assessments.
It’s confusing, so here’s an example to illustrate the point: Let’s say a homeowners’ association has a $10,000 deductible on an insurance policy. A hail storm hits the building and damages the roof. The association then files a claim with its insurance company. After an inspection, the cost to repair the roof is $50,000. The insurance company pays the association $40,000 and the association absorbs the $10,000 deductible cost.
Now, the association turns to its owners to make up that $10,000. They bill the homeowners for their proportionate share of the $10,000 special assessment. If you are one of 10 homeowners and each of you are 10% owners of the total property, then each of you would owe the association $1,000 to cover your share of the special assessment.
Ah, but you have an insurance policy for just this sort of thing. At this point, if you have the endorsement on your insurance policy, it may cover you for this special assessment, depending on the deductible on your policy. If you have a $1,000 deductible, you’ll be out of pocket.
We can easily imagine that this insurance coverage can help you in some situations, particularly if the special assessment is far higher or your deductible is lower. But many special assessments have nothing to do with insurance losses and claims.
Associations may decide to replace the roof, hallway carpet or windows because they’re old. They may want to improve common areas, install or upgrade a workout room, redecorate lobbies, or do many other improvements and repairs simply because things break or wear out, and no one wants to buy a home if the property looks worn down and out of date.
If an association has substantial reserves, it may elect to pay those expenses out of the reserves. But, when an association has little or no reserves, the association has two choices: It can finance whatever repairs or improvements are needed or go ask the owners to pay for the repairs in a lump sum.
Either way, the owners will have to come up with the money to fund those improvements or repairs.
If the association elects to finance the work, it may simply increase the regular monthly assessments by enough to cover the work and then use the increase to build up reserves. But it may also elect to institute a special assessment, which will either be in one lump sum or paid out of a specific period of time. Either way, we don’t believe your insurance policy would cover this sort of special assessment.
As we mentioned in our column that discussed association reserves, this is one reason to keep a keen eye on the workings of your association. If you’re thinking about buying into a condo building, make sure you look at the property’s finances and ask specific questions about what work is being planned and how that work is going to get paid for.
Many readers wrote to say that there are no hard and fast rules when it comes to the reserves that you should expect to see from an association. (True, although there is at least one organization working on a scoring system for association reserves that is scheduled to be released later this year.) Even if you look over the association board’s minutes for the past few years, you may not know what issues the property will have during your ownership.
But it’s better than nothing. Take the time to read the minutes, building reports and budget for the upcoming years, then walk around the property (not just your unit) with your home inspector. Always look at the condition of the building and its finances before you sign on the dotted line and close on the purchase. If you see something, be sure to ask the seller, the agent or the building’s management company before closing. Don’t wait until you move in.
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