Actual Cash Value Property Insurance Unlawful for Most Community Associations

July 10, 2014Minnesota

Ensure Policies are Compliant to Avoid Costly Liability

Residential community associations could be breaking the law just by having certain insurance policies in place. According to the Minnesota Common Interest Ownership Act (MCIOA), associations bound by this statute are not legally allowed to purchase property insurance policies with actual cash value (ACV) coverage unless it is the only option available to them.

The Problem with ACV Coverage
Property insurance policies for community associations can, broadly speaking, be purchased with “actual cash value” (ACV) or “replacement cost” coverage. These terms refer to how the insurer will determine the amount of money it pays in the event of a loss. Stated simply, replacement cost coverage will cover the full amount to replace or repair the damaged property, while ACV typically includes a depreciation factor, lowering the amount.

There’s nothing inherently morally objectionable to ACV coverage. In fact, it can be financially advantageous, especially if the property owner or owners opt to self-fund depreciation costs. Premiums for this coverage are typically lower than those with replacement cost coverage. The problem, however, is primarily a legal one. Attorney David Hellmuth, founding partner with Hellmuth & Johnson, PLLC, the Twin Cities real estate law firm with a strong community association practice, wrote an article and a legal opinion confirming MMA's stance that ACG coverage is illegal for most associations in Minnesota.

Occasionally the marketplace simply will not offer replacement cost coverage for a particular association. In this case, an association is allowed to purchase ACV coverage. This is often referred to as the “reasonably available” clause in the statute. Some associations have argued that this clause gives them the option to purchase ACV coverage if replacement cost coverage is much more expensive. That is not the case. If replacement coverage is available, an association is legally obligated to choose it.

Hellmuth writes: “Based on the provisions of MCIOA, it is clear that community associations covered by MCIOA do not have the option to obtain actual cash value coverage, since the statute specifically requires full insurable replacement cost coverage. Associations governed by MCIOA should verify with their insurance agents that they are carrying appropriate coverage.”

Potential Consequences
Property owners, managers and even association boards of directors could open themselves and their organizations up to additional liability for not following the law or providing erroneous advice or service. Because many directors and officers (D&O) liability policies covering association boards exclude insurance decisions, improper insurance coverage could result in significant legal fees, fines, and settlement or judgment costs for the board and/or its individual members.

Additionally, a property management company or individual recommending or purchasing ACV coverage could face liability—and the associated costs—from those decisions or actions that lead to an association having ACV coverage when not allowed by law.

Action Steps
Ensuring your policies are adequate and legal is quite easy. If you have any doubt about whether you have ACV or replacement cost coverage, immediately contact your agent. He or she should be able to tell you what type of coverage you have in place.

If you do have ACV coverage, find out why. If ACV coverage is the only option available to you, you’re fine from a legal standpoint, but you may want to evaluate your finances to ensure you are adequately reserving for potential future claims. If you have ACV coverage but replacement cost is available, you should consider switching immediately to the legally-compliant policy.

Please contact us if you have any questions or want more information.