We believe a number of community associations may have a gaping hole in their fire and casualty insurance about which they are unaware. Virtually all condominium associations and most planned developments that have attached units require the association to carry fire and casualty coverage for the “full insurable replacement cost” of the common areas, association-maintained areas, and sometimes even the residences. Many associations have policies that provide “full replacement cost” or “guaranteed replacement cost” coverage. This terminology may give a board or community manager a false sense of security about the adequacy of the association’s insurance coverage. The problem, from a legal standpoint, is that building codes are being strengthened constantly, as the years go by, to improve fire, earthquake and other safety standards. Inevitably, these code changes also increase the cost of reconstruction. Unfortunately, full replacement cost policies often provide for reconstruction of the building as originally constructed, but do not cover the extra costs needed to meet all the subsequent code changes since original construction.
When a building is partially damaged, the repairs may require some code upgrades in the area where the damage occurred. The additional cost for complying with such code upgrades may not be significant, as long as the damage is confined to a relatively small area. However, if the building sustains major damage, the local building department may require the entire building to be reconstructed to meet current building codes. The cost to rebuild in compliance with current building codes could significantly add to the cost of reconstruction. Obviously, the cost for code upgrades becomes increasingly larger as the development gets older and older, and as more and more building code changes become law. After ten to twenty years, or longer, the cost of code upgrades in one building could be ten to twenty times the association’s deductible, or even more. If significant damage were to occur in multiple buildings, the cost of necessary code upgrades could be astronomical. Most standard fire and casualty policies for associations do not cover code upgrades and will not pay for the required upgrades. Thus, unless the fire and casualty policy specifically includes “code upgrade coverage” or “increased cost of construction coverage,” or similar terminology, the board could learn too late that the association’s policy does not provide this coverage. The additional cost of construction could be overwhelming.
Even for a relatively young association, a single major code change could have a sizable impact. For example, around 1994, San Diego County was reclassified from a seismic Zone 3 to Zone 4 for purposes of meeting structural standards to withstand stronger earthquakes. A building built to Zone 3 standards before 1994, if rebuilt, would now have to meet Zone 4 standards. Other code changes have been implemented in recent years to make residential buildings more accessible to disabled individuals. Certainly, many two or three-story multi-family buildings were built just with stairs leading to the upper floors. If those buildings had to be rebuilt to current building codes, an elevator may be required. It is not difficult to imagine the effect such changes might have on the cost of rebuilding, especially if they are not covered under the association’s insurance policy.
Typically, including code upgrade coverage in a fire and casualty policy requires the association to request it and pay an added premium. Note, however, not all insurance companies offer code upgrade coverage as an option. Thus, the board or community association manager certainly should ask the association’s insurance agent or broker whether the association’s policy covers code upgrades or not. If the broker says that it does, ask for confirmation in writing including a citation and quote to the exact section of the policy in which code upgrade coverage is found (or a highlighted copy of the page(s) on which the code upgrade coverage is found). Review the cited or highlighted section of the policy to confirm the provision the broker cited exists.
Brokers who deal regularly with associations know (or certainly should know), that most community association documents call for a master policy that provides coverage for the full insurable replacement cost of the buildings. If, due to intervening building code changes, it is now legally impossible to rebuild your buildings exactly the way they currently exist, would that full insurable replacement cost policy provide full coverage? We think not – unless the association obtains building code upgrade coverage. This is something the broker may or may not explain to you. Always be sure to ask.
We trust this information will help you to avoid a costly error if your association experiences a major fire or other casualty loss.