Letting the tenant insure the building on behalf of the landlord is rarely sensible
Last month I was involved in a claim, where the owner of a commercial building had a clause in their commercial lease that required the tenant to insure for full value. A second clause required the tenant to insure for Loss of Rent for 18 months. A third clause required the tenant to provide a Certificate of Currency confirming the insurance from the insurer selected by the tenant.
The tenant understood the requirements of the lease but, on obtaining quotations, elected to “take the risk” and under insure the building and not insure for Loss of Rent. What could ever go wrong? To hide the fact that he was in breach of the clear conditions of the lease, the tenant never provided the Certificate of Currency to the landlord. Despite being a practising lawyer, the landlord did not follow up the tenant for a copy of the Certificate, confirming the existence and levels of insurance.
When a fire occurred, the landlord heard about it on the radio and could not contact the tenant. He had a very anxious weekend and, when he rushed into his office to check the file to report the loss to the insurer, he could not find any evidence of insurance. He was understandably worried that the tenant had failed to take out any insurance.
He was relieved that there was some insurance in place on the building, but this was short lived when I explained the level of underinsurance and the amount of which he would have to bear himself. Like many property and business owners, he did not realise that the penalty for underinsurance applies on all claims once the loss is greater than either 5% or 10% of the Sum Insured/Declared Value. Worse was to come when he found that the rent was not insured at all.
His first thought was to sue the tenant, but the tenant was under insured on his own loss for Stock and Contents and had no other assets. Therefore, seeking recovery, notwithstanding the personal guarantee from the tenant that is contained in the lease, was just going to be a case of “throwing good money after bad”.
This of course is not an isolated incident. I have seen this countless times. So why does it happen?
The main reasons are:
- The landlord does not want to pay for a valuation to determine the full replacement value which is the amount to be declared for the building and so, thinks that by putting the onus on the tenant for full insurance, they are avoiding this cost.
- The landlord does not want to upset a tenant who believes they can buy insurance better than the landlord.
- The landlord does not want the hassle of arranging the insurance.
The reality is that in the vast majority of cases, the tenant is only interested in one thing: the cheapest possible insurance. It is not his or her asset, so why bother looking for quality with a broad range of perils covered and a good claims service?
The landlord in this and so many other cases has a lot more to lose when the insurance is not correct.
My advice to landlords is – do not transfer the risk to the tenant. The best way to protect yourself is find a good insurance broker, get them to arrange quality insurance on the building, landlord fixtures and fittings and the Loss of Rent for a period which will realistically cover the time needed to obtain all council approvals, rebuild and refit the building and find new tenants, plus any rent free incentive. The cost can then be passed on to the tenant.
Even then there are rules that must be followed:
- Always advise your insurance broker/insurer when the building is left unoccupied for the period stated in the policy. Typically either 30 or 60 days.
- Always advise your insurance broker/insurer when the occupation of the tenancy is changed.
- Check with your insurance broker/insurer if the tenant is a high risk occupancy before you offer the new tenant a lease. A good example here are tattoo parlours.
- Advise your insurance broker if there is any unusual risks with the building, such as non-approved works, any council orders against the building, if there is more than 30% EPS (sandwich) panelling or any asbestos.
Turning back to who should insure the building, my normal advice is that the landlord should not abrogate this important function to a tenant who does not have the same financial interest in the asset as the landlord. There are exceptions to this general rule, as there so often is. The exception is when the tenant is a blue chip company with a first class insurance program in place, with every bell and whistle imaginable. Even then there are three things that should always be done.
- Double check the policy excess / deductible and be satisfied as to who is responsible to pay this. I have seen cases where the landlord has to bear the excess and they find it is much more than they can afford.
- Double check each and every change in the lease to see if the rules on insurance are changed on you.
- Obtain a Certificate of Currency each year and have your insurance broker check it for any unusual or changed terms or conditions such as an increased excess or deductible.
The opposite can also occur. I am handling several cases out of the Wellington earthquake where the lease stated that the tenant was to pay the excess and with the earthquake deductible being 10% of the value of the building in some cases, this is causing massive problems for some tenants.
In summary, insurance is not something that a landlord should abrogate or leave to a tenant as a matter of course. If it is your asset then you are best to control the insurance yourself, by using a competent insurance broker that will ensure the coverage is in line with your risk appetite and that the Loss of Rent, including the outgoings paid by the tenant, are adequately insured for a period long enough to reinstate a major loss and replace tenants who break the lease.