It was just yesterday when you were daydreaming about how happy you were with your real estate investment. Then you got a letter in the mail stating, "This is your notice that we will not be renewing your property insurance upon the expiration of your current policy."

You sat straight up in your chair and thought, "What did I do to deserve this?"

Your insurance company neglected to mention that they would cancel your insurance when you reported the mold in the bathrooms of your 30-unit apartment property.

In this post-9/11-hurricane-mold-mildew-fire era, in this time of great losses and a weak stock market, insurance companies are faced with shrinking revenues and higher losses. To increase revenues many auto, home and commercial insurance carriers have started looking at new ways to minimize their losses.

Credit Checking

Within the last two years the Texas Legislature and the Texas Department of Insurance have completed actuarial studies regarding the correlation of credit and experience rating. They confirmed what the insurance industry already knows: if you have bad credit you are more likely to have insurance claims. Insurance companies across the country are using your credit score to rate your insurance. In this way insurance companies can charge those with bad credit more in the way of premiums.

CLUE and A-PLUS Reports

If you think your credit will present a challenge to obtaining insurance, you should be aware that insurance companies are now using the results of two data gathering agencies to collect insurance history about you as an individual: your home, your car, and the loss runs of your investment property.

The CLUE system, owned by Choice Trust, is the largest system of data gathering and is most used by insurance carriers. There is also another property loss database run by the Insurance Services Office called the Automated Property Loss Underwriting System (A-PLUS for short).

These reports typically include information such as a person's name, date of birth, social security number, history of any losses you might have had, the dates losses were claimed, and the cost of those losses. There will also be notations of property damage -- even if insurance companies did not pay out a cent. Typically the loss history stays in the CLUE records for five years.

You should be aware that the CLUE reports grade individuals as far as risk is concerned, and insurance carriers use these grades to decide how much they will charge you or whether they will deny you coverage.

What is wrong with CLUE reports:

1. Information can be inaccurate.

2. Information gathered may not even be related to you, your automobile or property you own.

3. Even if you make your own repairs to a damaged property, it may show up on a clue CLUE report.

4. Being a long-time customer will not help you keep insurance.

5. You and your property can be blacklisted by a CLUE report.

Loss Runs - Property Inspections

Commercial insurance companies (those that cover commercial buildings, apartments and mobile home parks) now require you to submit a five-year loss history before they will even consider insuring you. In addition, they will want to complete property inspections prior and during the time they insure your property. Just recently I showed up unannounced at a property we manage, and there was the Insurance Inspector looking for any problems that they might find. The commercial insurance industry does not yet have the CLUE system in place, but it is expected to be in place within the next few years.

Strategies To Limit Risk:

LLCs

Many investors are purchasing properties in single entity LLCs (Limited Liability Company) to protect their other assets. If you pursue this avenue, you might also want to consider additional umbrella insurance just for the LLC. By so doing you can expect slightly higher insurance premiums, but if you handle it correctly under the advice of your insurance agent and attorney, when you do incur a loss, the claim will be limited to the LLC and its assets.

Deductible – Self Insurance

Another strategy is to increase your deductible, to self-insure and keep the small claims out of reach of the insurance companies and the reporting services. In other words, instead of the $250 deductible think $1000 or $5000 and then set up a deductible reserve. Most large companies do this to save on fees and use the insurance for only large claims.

Renter's Insurance

Require your tenants to carry renters' insurance. This will protect them, make them more careful and will protect you and your property -- especially if they (or their guests) are responsible for any harm such as fire or water damage.

Exclusions

The insurance industry today is very different than it was 10 years ago. Mold and mildew claims are now excluded as are claims for water damage. If you have an older property, many insurance carriers will not insure you. A 100-year-old building with similarly dated electrical systems is hard to insure. Owners of buildings must keep their buildings up to date, not just to attract the next generation of tenants, but also to make sure that their buildings are insurable. This means new foundations, new rooms, siding in good condition, newer lead-free plumbing and lead-free paint. Even new earthquake standards are now an issue for owners. Clearly owning a newer building means you pay more for the investment, but you end up with fewer headaches on the insurance side of the investment.

Summary

As a property owner you need to be proactive about reducing your risk at your investment properties. Whether you own a rental house, an apartment complex, or industrial commercial property you face risk daily. You can reduce that risk by making sure your property is in good condition and that it stays that way. Inspect the property regularly to make sure you don't have trip hazards, mold and mildew growing, or a potential for flooding. Encourage your tenants to carry their own insurance so if they create any damage you are covered.

Buy a newer property. In doing so you will meet newer codes (which are always driven by safety), and it makes it easier for an insurance company to cover you. Buy your properties in single entity LLCs. Do a thorough job selecting tenants. Make sure that potential tenants have good rental records and credit histories. If you own a commercial property, stay away from tenants in hard-to-insure industries such as chemicals or automotive repair.

Finally, consider more self-insurance to reduce the number of times you have to report a claim to your insurance carrier. If you are proactive, you can limit the times you get the letter from the insurance company canceling your insurance.

Published: November 8, 2004

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Clifford A. Hockley is the President of Bluestone & Hockley Real Estate Services, one of the larger brokerage and property management companies in Portland, Oregon. Mr. Hockley holds an MBA Willamette University and a B.S. in Political Science from Claremont McKenna College. He is a Certified Property Manager and Bluestone & Hockley Real Estate Services is an Accredited Management Organization (AMO) by the Institute of Real Estate Management (IREM). Mr.Hockley serves as member at large on the Portland IREM board. He has twice been named Certified Property Manager of the Year (2001 and 2003) by the Institute of Real Estate Management and is a frequent contributor to industry newsletters.