Complying with Insurance Requirements for Association

July 26, 2018
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Q: The board of the association I manage is trying to reduce costs for operating the community. One way to do this would be to drop an insurance policy for specific risks, like flooding. What is the risk for the association of not providing this type of insurance?

A: Insurance issues for associations should be carefully considered. A recent North Carolina case demonstrates why associations must determine their insurance obligations before dropping coverage. In that case, an association maintained flood insurance for five of the buildings in its multi-building property. All five buildings were in flood zones as designated by the Federal Emergency Management Agency (FEMA). The association later decided not to renew the flood insurance policy, citing concerns regarding cost and the allocation of the expense among the other members of the association who lived in the non-flood exposed buildings.

The association notified all owners in the community of its decision not to renew the flood insurance policy in a detailed letter, in accordance with the terms of the declaration, which it asserted did not require flood insurance. The association declined several homeowners’ subsequent requests that the association resume purchasing and maintaining flood insurance on the five buildings.

The homeowners asked a trial court for a declaratory judgment that the association was in fact obligated to provide flood insurance. The trial court ruled in favor of the association. The homeowners appealed. A North Carolina appeals court reversed.

The appeals court reviewed both the state’s condominium act and the declaration. It noted that the act requires a residential condominium association to maintain insurance “against all risks of direct physical loss commonly insured against,” so long as the insurance is “available.” The appeals court pointed out that the declaration contains two sections that govern the association’s purchase of insurance.

The first section provides generally that the association is to maintain insurance coverage in accordance with the act to the extent that such insurance is “reasonably available.” The second section addresses property insurance specifically and provides that the association is to maintain property insurance against “all risks of direct physical loss.” Importantly, the declaration also explicitly provides that in the event of a conflict between the terms of the declaration and the act, “the provisions of the Condominium Act shall control.”

The association essentially argued that: (1) the phrase “all risks of direct physical loss” is limited in the declaration by the phrase “including fire and extended coverage perils”; and (2) the risk of flood is not a risk of fire or a risk commonly understood as an “extended coverage” peril. The association relied heavily on an affidavit from the attorney who drafted the declaration. In the affidavit, the attorney stated that flood is not an “extended coverage peril” and that the peril of flood is not “commonly insured against in property and casualty insurance policies.” However, the question is not whether the risk of flood is commonly insured against only in property and casualty insurance policies; rather, the question is whether the phrase “all risks of direct physical loss” is limited to only risks associated with fire and extended coverages, the appeals court said.

It concluded that the phrase “all risks of direct physical loss” is not limited by the phrase “including fire and extended coverage perils.” Had the intent been to limit the association’s obligation to maintain only those coverages contained in a standard fire and extended coverages policy, the community’s declarant could have stated as such. The word “including” indicates an intent to enlarge, not limit, a definition, it added.

The appeals court further held that “flood” is a risk of direct physical loss that is “commonly insured against” for residential buildings located in flood zones. FEMA is responsible for administering the National Flood Insurance Program (NFIP), which was created by the United States Congress “in order to make flood insurance available on reasonable terms and conditions to those in need of such protection.” The homeowners provided documentation from the NFIP showing that from 2006-2015, the program administered over five million flood insurance policies in each calendar year. At the time of the homeowners’ request for a declaratory judgment, FEMA’s flood policy statistics show that there are approximately 134,126 flood policies in force in the State of North Carolina. Approximately 1,062 of these policies are in force in the county where the community is located, said the appeals court, indicating that it is very commonly insured against.

The appeals court concluded that the trial court erred in siding with the association, and that the homeowners’ action for a declaration that the association was required to maintain flood insurance for buildings located in a flood zone was appropriate. It said that the association was obligated to provide flood insurance for those buildings inasmuch as the declaration required the association to maintain insurance coverage in accordance with the act to the extent that such insurance was “reasonably available” and to maintain property insurance against “all risks” of direct physical loss, and flood was a risk of direct physical loss that was commonly insured against for residential buildings located in a FEMA-designated flood zone [Porter v. Beaverdam Run Condo. Ass’n, May 2018].