Picture this, although it’s not a pleasant image.  A fire caused by an electrical short swept through your community last night.  No one was hurt, fortunately, but one building was destroyed completely and two others suffered extensive damage.  Your first thought as a member of the board of directors:  Buildings can be repaired or replaced.  Your second thought:  It’s a good thing our insurance will cover the costs.  But will it?
 
There is no question your association’s insurance policy should protect the community.  Associations in Colorado have a legal obligation to maintain the types and amounts of insurance their governing documents and/or the Colorado Common Interest Ownership Act (“CCIOA”) require. (Section 38-33.3-313(1) requires common interest communities to maintain, to the extent reasonably available, certain amounts of property and commercial general liability insurance.) If an association’s documents are vague, as is often the case, then boards must make a reasoned assessment of the association’s risks and insure against such risks adequately.   Failure to do so may constitute negligence, exposing the association and individual board members to liability.
 
The board, not the community manager or the insurance agent, has the responsibility to maintain adequate insurance.  However, Colorado law entitles a board to rely on the recommendations from its insurance agent pertaining to recommended coverage for the association and relieves it from liability by doing so.  Nevertheless, failure to obtain or comply with such advice, coupled with the failure to obtain sufficient insurance coverage, will expose the association and board to liability.
 
Despite the potential liability and common sense arguments for maintaining adequate insurance, many boards don’t have any idea what their policies cover until they drag the documents out of a drawer to file a claim. 
 
A Painful Mismatch
Needless to say, standing in the freezing rain, staring at the smoldering ruins of a gutted clubhouse or the rubble left by a devastating storm is not the time to discover the association’s policy will not provide the needed funds to rebuild.  However, this is the precise crisis your association could face if the replacement cost of the damaged buildings exceeds the value “assigned” to them by the insurer.  How could this possibly happen?  It happens because, over time, construction costs increase. 
 
Partly due to massive reconstruction efforts under way in hurricane-damaged areas of the Gulf Coast and other recent disasters, building costs have increased by more than 100 percent in the past six months alone.  This increase means an association that obtained a policy a few years ago sufficient to replace a building valued at $2 million would now have only half the funds needed to rebuild the building in the event it was destroyed today.
 
Associations may avoid the risk of such a devastating shortfall by obtaining a “guaranteed replacement cost” policy. This type of policy pays to restore a damaged property to its pre-disaster condition, even when the construction costs exceed the property’s assigned value.  However, not all insurance companies provide this type of coverage. 
 
If an association’s insurance company does not offer such insurance, or if an association declines to pay for the increased premium associated with it, an association should insure that its policy limits always match the estimated replacement cost of the association’s buildings. To accomplish this, the board should ask its agent to confirm the association is sufficiently covered or have an insurance appraiser review the policy at least annually and update the estimated replacement value based on current construction costs in the area. 
 
Closing a Gap
Accurate and updated replacement cost estimates still may not provide the protection an association needs.  Even a guaranteed replacement cost policy may leave an association short of the funds required to rebuild or repair a damaged structure.  This shortfall occurs from the specific exclusion of losses resulting from “governmental orders” that most policies contain.  “Governmental orders” include condemnation orders for damaged structures or building code requirements that may not have existed at the time of construction, but will apply to any construction or renovation undertaken today.  So, although a $1 million policy would be sufficient to restore an association’s damaged building to its original condition, it will not be sufficient to cover the added cost of installing sprinklers, creating parking spaces, increasing setbacks, or making other changes a modernized building code may require.  To close this gap, associations need ordinance or law coverage, which is available as a fairly low-cost endorsement to a standard master policy.  
 
Another potentially serious insurance lapse associations often encounter occurs not in their association policy, but in the coverage individual owners should have, but often do not obtain. Many owners assume incorrectly the association policy covers everything, including their residences and everything in them.  This misconception is a problem not just for owners, who may have huge uninsured losses, but also for the association itself. 
 
Uninsured or under-insured owners may not be able to pay their share of the association policy deductible, or may not be able to make needed repairs for which they are responsible.  For example:  Untreated water damage in one unit could trigger a mold outbreak affecting adjacent units and the common areas.  In communities where owners have the obligation to insure their units but fail to do so, this scenario could have devastating results.  Because associations have a clear and compelling interest in ensuring that owners obtain adequate individual coverage, attorneys are increasingly recommending that communities amend their documents to make this a requirement. 
 
Property values, risk profiles, and insurance requirements all can change over time, so boards should review their insurance policies periodically, to make sure they have and maintain the coverage they need.  As part of this periodic review, boards should also assess, or reassess, the financial strength of their insurance carrier.  Having adequate insurance in place won’t help much if the association’s insurer doesn’t survive. 
 
Termination Clauses
Recovering from a disaster is difficult under the best of circumstances.  Therefore, boards should ensure that governing documents don’t have provisions that will impede recovery efforts.  Many documents contain a potentially significant stumbling block in the form of an automatic community termination provision. Such a provision specifies that if the renovation costs exceed a stated percentage of the development’s market value, the association will be terminated, unless a specified percentage of the owners vote to rebuild. 
 
Despite the prevalence of such provisions, it is hard to imagine many situations in which rebuilding would not be the best choice.  Displaced owners will need some place to live, and while the association’s insurance should cover the replacement value for rebuilding purposes, it would cover only the current market value if the community were terminated.  Therefore, most communities would benefit by turning the standard termination language on its head, making the rebuilding decision automatic and requiring a vote of owners to terminate the community instead.  
 
Improperly drafted declaration provisions governing insurance claims could create more unnecessary problems.  For example, if the board is not designated as the insurance trustee authorized to receive insurance payments, disbursements could be delayed.  The association should also be named as the agent for each unit owner and for holders of liens on all units.  This will give the board authority to adjust all insurance claims under the master policy, including those covering damage inside individual units.
 
Before a board begins planning the reconstruction/repair of its community, it should review the association’s insurance policy to ensure compliance with all reporting requirements as well as all filing and notice deadlines. Many policies provide advance payments to finance emergency measures (shoring up damaged structures or removing debris, for example.) There is certainly nothing wrong with accepting those payments, as long as the board doesn’t sign any releases that might limit any future recoverable damages.  The association’s attorney should review any insurance documents, including the final settlement offer, before acceptance.  The board should ensure the compensation the insurer provides reflects the coverage to which the association is entitled. 
 
Proceed with Care
Once a board knows what the insurance will cover, it can begin formulating the reconstruction plans.  The pressure to rebuild quickly will be intense, but caution and careful planning are essential.  It is far more important to handle the construction project properly than to complete it rapidly.  A board should approach reconstruction as if it had not resulted from a disaster.  This includes, but is not limited to:

• Don’t hire the first contractor who arrives on the scene with a back-hoe, a construction crew, and a promise to “fix everything like new.” 
• Obtain competitive bids from at least three contractors. 
• Verify the capabilities and the reputations of all companies considered.  Check their references and demand proof of their insurance coverage.
• Before soliciting bids from contractors, have an engineering firm assess the damage to the community, and ask that firm also to prepare the specifications for the construction bids. 
• Once a contractor is selected, have the association’s attorney either draft the contract or review it before signing. 
• Plan to hire a construction manager to oversee the project; the association’s property manager probably will not be the best choice for this task.
• Have both the construction manager and the association’s consulting engineer monitor the project by reviewing the work and workmanship at every stage.  You don’t want to find out at the end of this process that your disaster recovery project has left the association with another disaster on its hands.