Most insurance policies contain a deductible. Small deductibles usually mean higher premiums. High deductibles means lower premiums because the association is sharing risk with the insurance company.
Paying the Deductible. When a loss occurs from property damage from a water leak, the question of "Who Pays the Deductible?" ultimately comes up. If the association is obligated to pay and if the deductible is small, associations will cover it from their operations account. When the deductible is large, boards may need to impose a special assessment on the membership to cover it.
Assuming the CC&Rs are silent on the issue, boards may adopt a policy on how to handle the deductible in the event of a loss. If, for example, the association's property damage insurance has a $5,000 deductible and an owner suffers a $20,000 loss due to water damage from the unit owner above, the deductible can be handled in one of the following ways:
1. Origin of the Loss. If a loss can be attributed to an owner's negligence or intentional acts that result in a claim against the association's insurance, the owner that caused the loss pays the deductible. That means the person in the upper unit that flooded the lower unit (if due to his/her negligence) pays the $5,000 deductible. The board can hold a hearing and impose the cost as a reimbursable special assessment against the owner that caused the loss.
2. Benefit of the Coverage. The lower unit that benefited from the association's insurance pays the deductible. In reality, the person does not actually pay the deductible, the $5,000 is deducted from the $20,000 loss so the amount paid to the lower unit is only $15,000 instead of $20,000. If the person in the lower unit wants to recover the $5,000 withheld from the payout, he can sue the owner of the upper unit in small claims court.
3. No Negligence. If no negligence or intentional act caused the loss, the deductible is (i) covered by the association, or (ii) apportioned against all claimants according to the percentage each claim bears against the total of all claims for the loss. For example, the unit owner suffered a $20,000 loss to his unit, and the association suffered $10,000 in damages to the common areas. That means the unit owner is responsible for 2/3 of the deductible ($3,333) and the association is responsible for the remaining 1/3 ($1,667). As noted above, no one actually pays the deductible, the proportional amounts are deducted from the respective payouts.
Saving for the Deductible. To avoid special assessments to pay large insurance deductibles, some associations set aside funds to pay the deductible in the event a loss occurs. The question is where to put the money.
1. Operations. Insurance deductibles do not fit into operations because they're not an annual expense. The payout of a deductible depends on the filing of insurance claims and associations can go for years without a claim. I don't like putting it in the budget because it means the deductible must be fully funded in the 12-month budget cycle, which may put a strain on some budgets. It also creates a surplus at the end of the year, assuming no claims are made. Nonprofit corporations are supposed to break even, not run planned surpluses.
2. Reserve Account. Because deductible payouts are periodic, they seem to fit into reserves. However, they don't meet the definition of a reserve component. Their life cycle is not predictable and may not involve the repair or replacement of a major common area component. Even so, the reserve fund appears to be the better place for insurance deductibles--it allows funding over 2 or 3 years and avoids annual budget surpluses.
3. Deductible Fund. The best way to handle the issue is to create a separate fund but keep the monies in the same account as the reserves. Associations can a line item in their budgets for an "Insurance Deductible Fund" and contribute to the fund over 2 or 3 years. If the insurance deductible is $10,000, boards could budget a modest $278 per month to the fund. At the end of three years, the insurance deductible would be fully funded. At that point, the contribution could be discontinued until an insurance claim is made, at which point the deductible would be replenished with new contributions.
In the alternative, the contribution could be permanent to avoid ups and downs in the budget. At the end of the three years, and thereafter, any excess funds in the deductible fund could flow into the reserves. This provides for a smoother budget and has the added benefit of building the reserves.
When Deductible Starts. The deductible obligation does not begin when the association starts incurring expenses. It starts when the board tenders the claim to the carrier. That means the board cannot apply pre-tender expenses against the deductible. This situation occurs most often when the board involves corporate counsel and incurs significant legal fees before finally tendering the claim. If the board immediately tenders the claim and then causes significant legal expenses, those expenses can be credited against the deductible obligations.
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