QUESTION: Should the association's insurance be primary and if so should the CC&Rs be amended to state that?
ANSWER: There is no law that requires an association's insurance be primary. If your governing documents are silent, then it depends on whether the board wants to expand the pool of potential buyers of condominiums in the development. If so, associations must comply with Fannie Mae requirements.
Fannie Mae. The Federal National Mortgage Association (Fannie Mae) is the nation's largest player in the secondary mortgage market. Fannie Mae operates differently than FHA; instead of insuring loans, it buys FHA insured loans from lenders. To qualify, Fannie Mae requires that an association's master policy be “primary.” Doing so protects lenders who often rely on the association's insurance to protect their collateral, i.e., condominiums that secure their loans.
Rebuilding Common Areas. The HOA's insurance pays for rebuilding the common area elements surrounding the condominium in the event there is a major loss. Without the surrounding structure, the condominium (which is air space) has very little value. If the common areas are not rebuilt, the borrower will likely walk away from the loan and the lender will foreclose on useless air space. Lenders want to make sure HOAs have the funds they need to repair and rebuild the common area structure. Hence, the requirement by Fannie Mae that the association's policy be primary. As a result, lenders who sell their loans to Fannie Mae will refuse to lend in developments where the association's insurance is not primary.
Laws Are Silent. Since California's Civil Code and Insurance Code are both silent on the HOA’s master policy being primary, it is up to boards and insurance agents to address the issue. Many of the better master policies specifically drafted for condominium associations already have the “primary” language built in but there are plenty of other carriers that do not have the language.
Overlapping Insurance. Making the association's insurance primary eliminates another problem--the issue of overlapping insurance. One of the many problems with poorly written CC&Rs is when two policies (owner and HOA) cover the same property. Whenever this occurs there is the risk that insurers will invoke their "other insurance" clause. Following is a typical clause:
Other Insurance. If a loss covered by this policy is also covered by other insurance, except insurance in the name of the condominium, we will pay only our share of the loss. Our share is the proportion of the loss that the applicable limit under this policy bears to the total amount of insurance covering the loss.
When carriers invoke this provision, loss payments get bogged down or stalemate as carriers argue over coverage and their proportional share. This can be avoided with the following solutions:
1. Amend CC&Rs.
a. Maintenance Defined. HOA CC&Rs should clearly define the maintenance duties of members and the association, especially when it comes to exclusive use common area.
b. Insurance Defined. CC&Rs should clearly define the insurance obligations of members and the association. When there is clarity, insurers can easily fulfill their coverage duties.
c. Primary Defined. CC&Rs should designate the association's policy as “primary” so the association pays first, regardless of any other insurance covering the same risk.
2. Policy Language. If an association’s CC&Rs are silent as to which policy is primary (owner or HOA) and amending the CC&Rs is too difficult, insurance purchased by boards can always be more stringent than the CC&Rs require, just not less. Thus, boards can require that the association's policy be written to be "primary," thereby satisfying Fannie Mae guidelines.
Recommendation: If associations want access to an expanded pool of buyers, they need to make their insurance primary. Because of the ever-changing FHA, Fannie Mae and Freddie Mac standards, boards should use insurance brokers who specialize in homeowner associations. In addition, boards should have legal counsel review and, if appropriate, amend CC&R maintenance and insurance provisions for membership approval.
ASSISTANCE: Associations needing legal assistance can contact us. To stay current with issues affecting community associations, subscribe to the Davis-Stirling Newsletter.