13 Myths About Insurance For Real Estate Investors – Video
Ivan Oberon: Hi, I’m, Ivan Oberon. I’m the West Coast regional sales director for a Real Estate Insurance company. Also, the co-founder of Steadfast Capital LLC. I am very grateful to be here, to talk to you about a subject that I think we’re all going to agree needs to be much better understood. I don’t know any of all that legal stuff, but I think insurance for real estate investors is near and dear to my heart because I am an investor.
I do stand before you as one of your greatest advocates because I am an active investor. I’ve been flipping houses for many years and now I focus primarily on cash flow. Just like many of you, because I think that that’s the future and I thought that was the best thing to do. Today we’re going to talk about what we’ve identified as 13 insurance myths for the real estate investor. That sound like a good idea?
Ivan: The first myth is that insurance is exclusive of estate tax and financial planning. I see this on the social media websites like questions being asked, “Hey, I have insurance so I don’t need an LLC,” or vice versa. This is a lie, it’s a myth and you need a good asset protection strategy in place first.
Insurance is not a panacea, it’s not going to cover everything. The easiest way to think about it is figure insurance is your archer on your tower. It picks off all the stuff that tries to come at you. Asset protection and your attorneys and all that kind of stuff, estate planning. Those are your mote and your castle walls that are protecting the stuff.
That’s the way it is, it should not be the primary foundation. It should be incorporated into everything that you’re doing. We’re going to talk about how to do it right here. How many of you here have done a Subject-2 deal? Purchase of property, Subject-2? We’re going to go into this just a little bit for your benefit in case anybody else gets into this in the future but being named as an additional insured on existing homeowner’s insurance policy is fine.
That’s the way a lot of people do it. They think, “Well, it’s easy enough.”There’s two scenarios really, it’s easy enough to just keep the existing homeowner’s policy in place and have them add me as additional insured. She’s shaking her head, she’s smarter than the average cookie. There’s a couple of issues that come up here, one because you’re the additional insured and now that property is no longer owner-occupied, there’s been a significant change in the exposure. What does that enable the insurance company to do in the event of a claim?
Participant: Deny it.
Ivan: Deny the claim. If by some miracle the insurance company actually pays, who’s going to get paid? Not you. You’re not going to get a dime of that because you’re not listed as the first named insured. Now the second scenario, somebody got a little bit smarter and said, “I’m going to keep that homeowner’s policy in place.” Why do you think that they might do that? What’s the biggest concern on a Subject-2 deal that comes up sometimes? Due-on-sale clause.
We don’t want that due-on-sale clause being called and the note being a call-due. We’re going to keep the existing policy in place and we’re going to take our own insurance policy out and list ourselves as named insured so that’ll be better.
The problem here is that both of those insurance companies are going to have what’s called an Excess Clause in their contracts. That means that they will only pay in excess of whatever other insurance is already in place. Both of them have that clause. How long do you think it’s going to take for you to get paid? It probably won’t happen.
What’s the right way to do it? What we do is we write a landlord type commercial policy listing you as the first named insured, the owner or the seller as the additional insured and the bank as the mortgagee.
In 15 years of doing that we’ve never had a note call because it’s the right process. The bank still sees that that person still has an interest in the policy. Anybody that does First Trust investments? Maybe you’re buying properties but maybe you’re doing a first trust deed to get a little bit better return or something like that. Well, you need to be listed as mortgagee because you’re Wells Fargo. That’s all you are. You hold that first trust deed so mortgagee not additional insured.
All right, number three, buying a property in your personal name and using your homeowner’s policy liability is fine. Anybody think this is true? There’s some issues here that we have to address. What you have to understand is the IRS considers anything that generates income for you, like a rental property, a business exposure, a business activity. You want to make sure you’re keeping your personal activities separate from your business activities even if they’re owned in your personal name because their activities are different. Now, these next two tie into each other.
The personal dwelling fire policy and what happens is you have an all estate and it insurers your home, it insures your autos. “Hey, I bought a rental property. Oh, sure we’ll ensure that under our personal dwelling fire policy.” The problem is, they don’t understand that it’s a business-related activity and they’re going to lump it all under your personal liability when we talked about umbrella policies.
You start buying rentals, insuring them under a personal insurance policy, “Man, I need an umbrella policy and I need a million dollars. I need two million dollars.” We’re going to talk about how you separate those two things because it is important to have your personal liabilities covered in the event that– Brent probably told you a lot of horror stories of somebody driving to school and hitting a bus and killing three children and that’s all personal liability, you should have had $15 million in coverage. You want to keep those things separate.
There’s always going to be additional excess under your business policy and here’s the umbrella, number 5, having a personal umbrella policy so I don’t need commercial insurance. You do need a personal umbrella policy but you also need excess business insurance or commercial insurance as we call it to protect your business liabilities. In your cases it’s all your rental properties.
How much is enough? He says three to five million dollars because of his activities or his experiences here. I use this rule of thumb, you want to make the insurance company or your liability protection more attractive than your current net worth- only you know that. Your perceived net worth– all right how many of you think your perceived net worth is much higher than your actual net worth?
Ivan: In my previous life, I was a regular P&C guy before I got into investing and learned all this cool stuff. I live in Camarillo, so we have a lot of agriculture out there. I did a lot of insurance for farmers. You see the guys owning 500, 1000 acres their perceived net worth is pretty high.” You see 10 rental properties on your portfolio your perceived net worth is really high.
Even if you bought in a really bad area that looked really good on paper, but then you bought it and then actually you needed $25,000 to rehab it and it wasn’t occupied. Not that I’ve ever seen anybody run into that.
The third thing is your potential future net worth. Brent talked about, “Well, how long can they come after you for, they can just keep renewing it every every 10 years.” Maybe there’s going to be something juicy that comes along. Maybe you’re struggling right now but you’re going to hit down the road. Your potential future net worth through the growing of your assets and maybe an inheritance, all those different things so within reason, because of the insurance premium you have to be able to make it reasonable.
Within reason, you want to make sure that it’s more attractive than those things so they don’t they don’t get incentivized to come after you personally. They’re going to come after your insurance policy. Does that make sense? Now we’re talking on a personal side.
Number six, a claim that occurred before I owned the property should not affect my rates. Does anybody run into an issue where you bought a property, they run a CLUE report but finally there was a loss and they said, “Well, we’re not– they’re not going to insure it we’re going to charge you more?” Anybody?
Okay, well prepare for this to be an issue. It didn’t used to be the case. It was always that the losses followed the previous owner and the insurance company might say, “Well we just want to verify that these repairs were adequately done before we place covers on here but it’s not going to affect you.”
What’s happened now is insurance companies are using, in certain states especially, not only your credit score but also the homes previous claims history to determine your premium. You want to watch out for that. Make sure you do business with the company that doesn’t operate that way just to keep your keep your bottom lines down.
Participant: How can you check that before you buy your property?
Ivan: Well you ask them. You’re going to get a proposal or they’re going to run these reports through their underwriting process and the CLUE report on personal lines– and personalized companies and I’m going to tell you to go away from that but in personalized companies they always run a CLUE report. Any time they’re going to do your proposal or something on a property they’ll run that. Then they’ll be told “Okay well you have to charge this or you have to ask for these things through the underwriting process.” Your agent will know the agent will know.
Okay, we’re going to spend a little bit of time on this slide.People think that all policies and coverages are created equal. They say, “Well, I got this quote from so and so and it’s the same thing.” We’re going to spend time identifying what some of these things are. There are three basic, or three main, policy provisions that a policy is written under. Basic form which is basic law settlement provisions, broad form, and special form.
I’m not going to put you to sleep explaining exactly what those things are, but it’s pretty easy to understand if you had the option to go with special or basic, which do you think you might want better?
Ivan: Special, in most cases you might chose a special, but as an investor once you understand what these things are and the type of property that you are buying and different things, it might make sense to go with basic form in some cases. That’s why you educate yourself. The main thing to understand about basic form as far as the differences, besides the fact that there is about 30% difference in premium, is two main things that are excluded in basic that are included in special are water damage and theft.
There are a few other things that really don’t matter. The difference between the forms is one of them is what’s called a named peril policy form, which means that they’re going to have their list of coverages and they’re going to have their list of exclusions, specials and all peril policy form.
Now, what that means is that as long as it’s not on the exclusion’s list, there is potential for the company to pay out. That’s one of the reasons that it’s much, much better. The other two things are actual cash value and replacement cost value. Have you guys heard those terms before?
Okay, do you know the difference between the two, just the basic differences? One person nodes their head, okay. Really all it is, is that actual cash value settles your claim minus depreciation. Whatever the damage is to that particular thing, they’re going to go ahead and depreciate it.
Say there is a loss to the house I mean, of $100,000. They say that because the house is 20 years old and now these things have never been updated, there are going to be certain things in there that are going to depreciate based on that timeline. Because, that useful lifetime has expired by that many years.
Replacement cost simply means, they’re going to settle the claim without taking depreciation into effect but of course your deductible still applies. In some cases it makes sense to insure for actual cash value. Some cases you’re going to go with replacement cost. Every claim even if under the replacement cost, every claim is first settled on a national cash value basis. If the claim exceeds what the actual cash value settlement is, then they submit it through replacement cost for those things. Whether it’s home owners it’s going to be things like TV or electronic equipment, furniture, cabinets, all that kind of stuff.
They’re not going to depreciate it, they’re going to give you whatever the full replacement cost value is. One of the things that you care about, probably most as an investor is co-insurance, the co-insurance provision and co-insurance requirement. Have any of your agents talked to you about co-insurance and do you know what it is?
Ivan: It’s one of the biggest issues and one of the ways that insurance companies charge you more premium. I’m a consumer just like you, when we created these programs even though we’re tenured insurance guys, we wanted to keep our premium down or at least have the ability to pick and choose the coverages and the structure that we want. It used to be that and I know the lady in the back she used to review loans and stuff, so she knows this.
A lot of insurance companies used to insure under what’s called, guaranteed replacement cost basis. What they were doing is, they were guaranteeing that if your house burns down they’re going to replace it, pretty much no matter what as long as you’re here. Here is the covers that we agreed on, loss happens it doesn’t matter if the construction cost went up or down or whatever it is, we guarantee we’re going to do it. Sounds like a pretty good deal, but then what happens?
Hurricane Hugo and Andrew came about, hit Florida and the Carolina’s and thousands of insured locations were hit. A lot of insurance companies went out of business, a lot of them took a really big hit. Guess, what? Do we still get the request from mortgagees guarantee replacement cost, guess what? It doesn’t exist anymore. Now, that it does not exist anymore, now they have what’s called a co-insurance requirement.
What that means is, when you’ve gotten insurance, the agent comes back and tells you, “Well we think it’s going cost this much, let’s say $200,000 to rebuild this house.” They run a Marshall and Swift and this is what it’s going to take. The co-insurance requirement means, now we’re saying, “We say you’ve got to go for at least $200,000, our co-insurance requirement is 80% of that or 90% of that. Some insurance companies will have it be 100% of that.
You’re a real estate investor and you didn’t spend $200,000, you got a good deal. You bought it for $100,000, all your invested capital is $100,000 and you know that you could probably rebuild it for $120,000. You don’t want to insure it and pay the extra premium at $160,000 or $180,000 or at $200,000 so you decide you want to insure for less. Everybody with me so far? Now, a claim happens, the insurance company is going to say “Okay, how much less did you insure it for?” Then they consider that your under-insured value.
Let’s say you’re 30% under-insured based on their strong arming co-insurance requirement, “Well thank you very much, now we’re going to pay your claim minus the 30%.” That’s your co-insurance penalty.
You’re under-insured 30%, we’re going to pay that claim minus 30%, minus your deductible. Makes sense? One person shakes their head, no. The take away here is ask your agent about co-insurance and if possible, work with a company that won’t hit you with a co-insurance requirement. Very, very few of them out there.
Ivan: Myth number eight. As real estate investors you have to understand there are different types of losses. As an investor you understand that the insurance premium you pay is what? It’s a loss, to your business, to your profitability and the deductible is one of the only ways that you have control of those premiums that you pay. You can choose what kind of deductible you have and mitigate those costs. Especially as your portfolio grows, it’s crazy people, I still know people– it only happens on personalized policies but $500,000 , $1,500 deductibles, that’s crazy.
Rule of thumb is on this, think about what the minimum claim that you would file and spend the time and get that loss on your history report and go through the trouble of doing all that by filing a claim, think about what the minimum number that is and at least double it. That’s a pretty good area to keep your deductible at.
There are two different types of what we’ve talked about as far as self insuring. Property is one of them and that’s one thing I think a lot of people are most focused on. “What if there’s a loss to my property?” They don’t think about the other side, the liability part, right? The property stuff can be a nuisance it might bend you, all right. It’ll bother you or it might bend you. That’s my little loss prevention thing. It’s a thing called bother, bend or break.
Things that will bother you, you retain those. Your deductible, minor claims, that sort of thing you retain those. Things that will bend you like, “Oh man, that’s going to hurt for a couple of months.” You consider that but you might retain some that, you might transfer some of that. Then there’s the breaks.The breaks are the thing that you always transfer. Meaning get insurance on it.
There’s people that self-insure their property altogether. They might have bought a pool of properties and there are some vacant ones they’re not sure what they’re going to do with them. They’re going to renovate them hopefully, and put a tent and eventually but they’re more worried about these other things, they get self-insured for those $15,000 properties, maybe $20,000 property.
Should you self-insure the liability piece? Who’s comfortable with that? No, never self-insure the liability piece, even if you’re going to own a property for a day or two, get liability on that location. Under our schedule it costs like seven bucks for a month for a million dollars in liability, just add the location just for liability just for a day or two if that’s all you’re going to keep it for, because anything can happen.
Say you only own it for two days or a week, they can come back later on, down the road and say something happened during that two days or a week that you owned the property and you didn’t have coverage and now you’re calling your insurance company. It’s worth it, so cheap to do.
Then, of course, there’s your claims reporting. You want to make sure that you are very good about keeping your agent, or your company, informed of everything that happens. I like to use the auto claim issue that we’ll lean into how this makes sense. Because how many of you have ever been in a small fender-bender? It was your fault and you decided, “You know what? Let me take care of that for you. We don’t need to file a claim.” Anybody done that?
Come on. Be honest. There’s one honest person. Three– five. There we go. I’ve done it too. It’s okay. That’s human nature. “Man, who want to deal with that nasty insurance stuff? It’s going to raise my rates. What’s going to happen?”
On the property side, let’s just say you have a great tenant. She’s a nice old lady and you really like her. She always pays rent on time. She doesn’t really have any maintenance issues. She calls you one day and she tells you that she got hurt walking up the stairs on the outside of your rental property. You know she really doesn’t have the money to go to the doctor. You think to yourself, “Man, she’s a great tenant. I don’t want her to leave. I want her to be happy.” “No, problem. Just go ahead and go and I’ll take care of it.”
You do. Everything’s fine, but about a week later, she tells you that she’s just in so much pain now. She needs to go back. You start thinking to yourself, “Oh, my God. What did I get myself into? This is going to end up being costly. Maybe I should report it.” Before you get a chance to do that, her grandson, who just loves his grandma and is an attorney and very sympathetic to her plight, calls you, and says, “You know what? I think you better report this to your insurance company.” What’s the problem? What’s the point I’m getting at? What you’ve done in trying to pay someone yourself, not reporting it, letting time lapse as you’ve handcuffed the insurance company, or limited their ability, to really defend you and pay your claim. It was a bad idea.
Always report it even if it’s just an incident. You don’t have to file a full-on claim. I did that this weekend. I have a client in San Luis Obispo, who owns a brewery restaurant. One of his employees has cut his hand on a piece of equipment. Not a big deal, just First-Aid medical, but we reported it as an incident. “Look, this is what’s happening. This happened. We’ll keep it under wraps. These are the exact details.” Because everything is fresh. Everything’s fresh in your mind at the time. You can get all the details, all the information, then you did your duty and the insurance company can come and protect you.
Again, this might not apply to a lot of you, since you’re not flipping houses, but you might buy a property that is going to be a rental but maybe it needs a little bit of work. That’s a possibility. This is one thing that I hear people talk about a lot. “Get builder’s risk insurance.” That’s a big myth. One thing you got to know is that builder’s risk, really, is designed for ground-up construction. It’s not really for your renovations and your little fix-ups and things of that nature but this is what you’re told.
You go and you call your insurance guy, and you say, “Hey. I need builder’s risk coverage.” He goes and he finds it and he gets you two quotes. One’s for $3,000 and one’s for $2,000. Which one would you think you might take? Maybe the $2,000, right? You go with that one but before it’s too late– or, by the time it’s too late, you found out that that $2,000 policy had a 100% minimum-earned premium. That’s a new concept we’re introducing now. The other one had a 50% minimum-earned premium.
What do you think that means? A minimum-earned premium is something that the insurance company says that we’re going to put this policy out here but we’re going to require you to pay at least 25%, 50%, or in some cases, 100%, of this premium is already earned as soon as a policy goes into force. You’re done with the renovation. Three weeks later, you try to cancel that policy and find out that that $2,000 policy– guess what? You have to walk away now from that $2,000 policy for premium because they had 100% minimum-earned premium.
The takeaway here is ask. A lot of companies don’t have minimum-earned premiums but commercial policies, like builder’s risk, they will all have at least a 25% minimum earned premium. You got to be aware of that.
I run into that a lot when I have people send me their portfolios and they want to shift coverage because they like the way our program is set-up. They like the fact that we understand how to insure them, the ease of use that we have, and all of the different things that we’ll get into later.
I look at some of their policies and say, “We can take these now, but we’re going to have to wait on these because they had a 25% or 50% minimum-earned premium.” It’s not worth it for you to walk away from $1,000. We’ll wait until that’s either expired or the policy renews. It’s just something for you to be aware of so that you know it’s there. Make sense?
Number 10. I was going to let you guys read that first because I think you guys probably have done this. It’s worth it to hire a handyman to do the maintenance on my properties. Many think this is the case. There are many gurus out there who are even telling people, teaching them how to flip houses. Telling them, “Don’t worry about how expensive it is to rehab houses. You can hire a handyman. You can do all these different things.” Anybody think this is a good idea?
Again, it’s a liability. Handyman is not going to have certificates of insurance. They’re not going to have bonds. They’re not going to have these things that you have to require. When you require somebody to provide you a certificate of insurance, when you get it, are you done? “This is good.” You file it away? Most people do. You call. You got to verify it. On that certificate of insurance, the agent’s name who is offering that coverage and their contact information will be on that. Call that agent. Make sure it’s enforced. Maybe send a reminder to yourself, two weeks later, call them again.
What would all these contractors do? They’ll get the insurance just to get the job, provide the certificate of insurance and then they’ll cancel it. In some cases, they’ll do a flat cancellation so they don’t have to pay any premium. You got to verify. It’s not enough to just ask for it. No. Handymen, especially with rental properties and self-managing and all that stuff, sometimes it’s just easier to get a handyman but, in the end, I don’t think it’s worth it.
Number 11. We’re going to touch on this a little bit. If I use my personal vehicle to service my properties, my personal auto policy is sufficient. How many of you self-manage your properties? God bless you.
My gosh. Hopefully, you don’t have any aspirations of scaling your portfolio to 100 properties or more. What if, you’re managing your property and you’re going to go do a service call, maybe you got to go put in some sod, maybe you’re going to go to change out a faucet, or whatever, and you’re doing a run to Home Depot or Lowe’s or Sherwin-Williams or whatever, and you get in an accident. What were you doing? What were you in the course of? Were you in the course of business or in the course of personal?
You’re in business. Your insurance company can deny that claim. You’ll be amazed to find out that getting one of those autos, especially if you have signage, especially if you do anything like that, one of those autos, moving it onto a commercial policy, or business policy, in many cases could be less expensive than on your personal auto policy with a million dollars in liability.
Then, of course, you have to tow that line because there’s an attorney in the room I’m going to mention this. Then, what? The car just sits there. You can’t go buy groceries with it. You can’t go pick up your kids from school because what if something happens there? It’s a fine line but depending on how much you’re doing, you got to think about it. There’s a lot of personal insurance companies out there, like Allied and Nationwide and all those companies, that might ask you during the underwriting process, “Do you have any signage on your car?” If you do, they’re going to say, “That’s a business exposure.”
Some of them are getting smarter and asking those questions. It might seem like a pain in the butt. However, they are doing you a favor because they’re pointing out that exposure. The fact that they don’t want to insure it because it’s not a business policy should be a red flag for you that made you doing something that you shouldn’t be doing.
Number 12. It’s enough to simply require renters’ insurance. A lot of you require it, a lot of you don’t. The issue is are you enforcing it? Because you can require it all you want but if you don’t enforce it– when you require it and they have it and they add you as the additional interest on that policy, you will be notified of any changes to that policy, as far as whether it’s active or not.
Just like as a mortgage, if a policy cancels for non-payment or for any other reason, you get a notification to, sort of cancellation notice. You should always know that, but it’s a little too late. You got it? You got to enforce it. A lot of the things that I think a lot of people run into is, maybe you have a lower end rental, right? You have a property, people that are paying $1,500, $2,000, $2,500 a month in rent, are not going to have to be told to get a renter’s insurance. They’re going to already understand that, “I got to protect my own property, because your policy isn’t going to do it.”
You got to pitch it to them in a way that it’s for their benefit, right? It’s not for your benefit, it’s for their benefit even though it is for your benefit but they’re going to benefit also. Not only that, they have personal liabilities, so they get sued because some of that happened, they need that renter’s insurance. Personal liability follows you anywhere you go in the world, how many people knew that?
It doesn’t pertain to your house, something happening at your house. If you cut somebody off, and they sue you for mental distress, guess what, that’s liability. If you go outside of Starbucks and say how crappy their coffee is, and their business suffers, now they can sue you for libel.
If you cause about the bodily injury or property damage to somebody else in somebody else’s house, or while you’re on vacation in Europe. That’s first cause of personal liabilities that are all covered under your personal liability policies and your umbrella policies, your personal umbrella policies. Same thing with that tenant, their personal liability under the renter’s policy follows them anywhere they go in the world. Something happens with their house, it’s covered. Something happens somewhere else, it’s covered. Did you know that more than 60% of property claims are caused by tenants? 60% of any claim that might happen on your property is going to be caused by your tenant.
Most renter’s policies out there will have a provision for about $300,000 for tenant-caused damages, and so what does that do you? It prevents you for having to file a claim against Europe policy and going through that process, and then getting acclaimed against your policy, as well, but it’s there as a secondary defense. Now, you always want them to be the first line of defense.
Okay, 13, “Cheaper is always better.”, is that true? No, maybe, sometimes? What you’re looking for is a combination of the right coverage, ease of use combination of products, that billionaires scale your business.
Everything that equates to the overall best value for what you’re getting, not just cheaper. We all know that cheaper isn’t necessarily better, right? You wouldn’t necessarily buy a cheaper pair of shoes or cheaper various organic food. You’re buying it for the right reason and you’re not going to pay what you’ve paid for all that food, with all the chemicals and everything else. Cheaper is not always better. Sometimes, you can get some comparisons where they are really equal, and of course, you’re going to go with the one that’s more affordable.
In many cases, it’s very difficult, especially in this industry, to do a true apples to apples comparison. Sometimes you can save money, but cheaper is not always better.