Property managers and brokers believed for years that condominiums should not make an insurance loss claim unless the loss is estimated to be three times the deductible. Seems to make sense. If your water deductible is $25,000, it may not be worth risking a premium increase to save $50,000. Certainly, however, a claim would be made if the loss were $500,000 or a cool million.
But what happens when the deductible is so high that virtually no claim can ever fit this rule of thumb?
The insurance crisis in condominiums is affecting how boards are planning for disasters in Ontario. With claims increasing in frequency and value, coupled with what the brokers call a hard market, many condominiums are finding their water-loss premiums doubling or tripling, while being essentially stuck agreeing to untenable deductibles ($250,000 in some cases).
Here are a few key points about reserve fund planning and spending as it relates to insurable losses for condominiums in Ontario.
1. Reserve funds exist to cover foreseeable major repairs and replacements of the common elements.
2. Reserve fund accounts can be used to pay insurance deductibles, provided the repair is to a common element.
3. The reserve fund is often used to pay for repairs to the common elements after an insurable loss if a claim is not filed.
That’s great knowledge to have after a loss. But how can a condo be proactive? Because insurance repairs are not foreseeable, they cannot be planned for as an expense in a reserve fund study. Market forces are creating an unplanned risk to reserve fund balances due to the likelihood of communities using their reserve funds to avoid a claim on insurable losses. What can we do before the next claim to mitigate the risk of a leaking toilet 200 feet in the air, wrecking the lobby and emptying a bank account that was needed next week to replace the 19-year-old roof?
Reserve fund planners cannot put a line item into a reserve fund plan that will allow for payment of a deductible. And even if they could, how would they know what year to put it in? Planners cannot assume that a tornado will come in 2021 and not 2022. And even if they could, how would they know if it will hit a specific condominium or not?
Assuming an optimized 30-year work requirement, planners only have so many tools to work with when creating a condominium reserve funding model: they can change contributions; they can special assess; and they can modify the minimum balance that the condominium will hold year-over-year.
Adequate funding of a reserve is based on the concept of maintaining an appropriate minimum balance—the minimum balance is the lowest value which the account will drop to over the duration of 30-year study. This value, typically developed by the planner in conjunction with the board, is based on factors such as the age and type of the condominium, the number of units, and the proximity to the year of the low balance and the year of maximum expenditures. This low balance is often a reflection of the condominium’s risk tolerance.
In this new world, where insurance deductibles and the potential to fund insurable loss repairs through the reserve put reserve fund plans at risks, condo corporations should speak with their planners about two options:
1. Ensure that the minimum balance at least allows for the deductible amount (that there is always enough money for the deductible, even if the claim is not three times the deductible value).
2. Ensure that the minimum balance allows for three times the deductible amount (that there is always enough money to ensure that a claim can be avoided if strategically reasonable).
In appropriately funded condominiums, adjustments to the fees to accommodate these options may not be overly noticeable and could add a level of security for proactive boards. In underfunded condominiums, however, these options will have the effect similar to an urgent unexpected expense, which can require aggressive contribution adjustments.
Condo corporation reserve fund planners will not know the details of a condominium corporation’s loss history and insurance agreements. It’s important that you communicate with them to ensure they have all the information. Corporations must consider the risks of maintaining a low balance that is below their deductible threshold and work with their planner to implement one of the options above.
Justin Tudor, P. Eng. is president and engineer at Keller Engineering, a building envelope engineering and building science firm that provides building and systems assessment and associated repair and renewal consulting services since 1982. He can be reached at jtudor@kellerengineering.com.
Great way to establish a claims avoidance strategy – most condos have at least their property damage deductible in reserve, often times many multiples of it. So, the issue becomes, in only a few cases, raising the lowest year to an amount relative to the deductible. One or two dollars per unit per month can have a remarkable effect in this regard. The 30 yr average annual closing balance for the last 300+ condos (27,500 +/- units) we have conducted studies for shows nearly $1.7M – many multiples of most deductibles. Of course the minimum was only $24K while the maximum was whopping $18M.
Very insightful article. It seems to me like the condo industry should be focused on tackling the insurance problem directly rather than saving a separate pot of money on the side in order to avoid claims. Paying premiums and additional reserve fund contributions with the goal of never making an insurance claim seems counter to the whole point of insurance to begin with. This is such an interesting topic that I think needs to be better considered. Increased efforts focused on reducing the likelihood of a claim (e.g. better preventative maintenance and proactive inspection programs) is perhaps more cost effective? Of course, it would help if insurance providers took such granular-level information into account when assessing their risks at a specific property, thus incentivizing such investments at the individual condo corporation level.