Untangling the intricacies of property damage insurance
Q. I am on our condominium board and we are currently reviewing our property damage insurance policies for annual renewal. We know the Illinois Condominium Act requires the association to have full replacement cost insurance. But, what does that mean and who is responsible for determining the amount?
A. Section 12 of the Illinois Condominium Property Act requires condominium boards to maintain property damage insurance in a total amount of not less than the full insurable replacement cost of the insured property, less deductibles and other policy conditions. The Act also requires the insurance coverage to include enough insurance to rebuild the property in compliance with current building-code requirements after an insured loss. That's important because a building that was legally constructed 30 years ago may have to satisfy current building codes when it is reconstructed after a major fire. Those increased code compliance costs can be significant.
The phrase “full insurable replacement cost” is often misunderstood or misinterpreted. There is a big difference between “replacement cost” and “guaranteed replacement cost.” For purposes of the Condominium Act, replacement cost means the amount it would cost, at the time the policy was purchased or renewed, to completely repair or rebuild the insured condominium property using like kind and quality of materials and workmanship without subtracting depreciation. It does not necessarily mean that the insurance company will pay whatever it costs to rebuild, no matter how expensive it becomes. There are still policy limits, deductibles, exceptions to coverage (aka “exclusions”) and other policy conditions that may reduce coverage amounts. “Guaranteed replacement cost,” by contrast, can potentially provide coverage above the stated policy limit when reconstruction costs exceed the stated coverage limit, depending on the insurance endorsement.
It’s important to note that the amount of insurance policy coverage is not based on the building's original construction cost, the association's tax assessment, the market value of the condominium, the aggregate sale price of all units or the property's land value. Moreover, the mere fact that an insurance company offers a policy labeled “replacement cost” does not, by itself, establish that the policy limit is adequate. There’s much more to it than that.
With regard to the responsibility for determining the amount of required coverage, the board has the ultimate statutory obligation to obtain adequate insurance. But the association’s insurance broker and the insurance company play a big role in helping the board meet that obligation. The insurance company and broker are ordinarily the professional source used by a condominium board to estimate and determine the appropriate replacement-cost coverage. The broker and company will help with the appropriate methodology used to recommend the replacement cost valuation.
Initially, the board and/or management will work closely with the insurance broker who gathers all the necessary building information for submittal to an insurance carrier. The agent may also recommend an independent insurance-to-value appraisal or replacement-cost appraisal. Ultimately, the insurance broker should provide the Board with a written replacement-cost/insurance-to-value review which will include current building replacement-cost valuation, current building coverage limits, inflation adjustments, construction-cost changes and any significant changes to the property which will impact the board’s decision.
Eventually, the insurance company will take all the building information from the broker and then calculate or recommend a replacement-cost value using factors such as square footage and number of units, construction type, geographic location, material and labor costs, architectural/engineering costs, code upgrade costs and inflation. With that, the Board can make an educated decision.
Once the board formally approves the insurance coverage purchase or renewal the board must make sure the decision is included in the board minutes. Minutes may state: “The board reviewed the Association’s property insurance renewal proposal, including the insurer/broker’s replacement-cost valuation, and determined to renew coverage in the recommended amount.” That creates a very good paper trail and identifies the board’s responsibility.
• Matthew Moodhe is an attorney with Kovitz Shifrin Nesbit in the Chicago suburbs. Send questions for the column to him at condotalk@ksnlaw.com. The firm provides legal service to condominium, townhouse, homeowner associations and housing cooperatives. This column is not a substitute for consultation with legal counsel.