3.9.2.4 Casualty Insurance

A. Also known as “fire and extended coverage” casualty insurance protects Borrowers (as well as Lenders and HUD) from losses caused by fire, storm, wind, and similar accidents or natural hazards. The Borrower must maintain extended coverage on the property, in accordance with terms and conditions established by the Commissioner, as required by 24 CFR 200.86.

1. Insurable values. The amount of damages covered, and the amount of coverage needed are both based on the replacement cost of individual buildings not including land or site improvements, meaning the actual current cost of replacing the building, not value or depreciated original cost. For each building this sum is known as its “insurable value.” The dollar amount payable in any casualty event will not exceed the actual cost of damages calculated on a building by building basis and for each building will not exceed the insurable value for that building. For this reason, methods of estimating insurable value that prorate gross cost among dissimilar buildings may under (or over) state actual replacement cost resulting in a risk of loss not covered by insurance. Most states regulate casualty insurance coverage and prohibit “over insurance” because it is an inducement to arson and insurance fraud. For HUD programs, replacement cost (insurable value) must be estimated for each structure in a property and is reported on the CNA report. (See Chapter 5 and Appendix 5, Section A.5.7).

2. Minimum coverage amount. Provided that any co-insurance requirement is met (see below), the Borrower must provide casualty insurance with a face amount that is the lower of: 80% of insurable improvements; or the balance of the insured mortgage(s). (See the form HUD-92447, section 5(a)).

3. Limitations of Borrower’s obligation to share cost of damages. HUD’s minimum coverage requirements protect Borrowers by limiting their obligation to share the costs of damages when a casualty occurs and by assuring that the insurance proceeds are sufficient to pay the commensurate portion of the principal amount of any insured mortgage(s) when a damaged building cannot be restored. Typically, insurers require Borrowers to share the cost of damages by one (or both) of two methods: deductibles, and co-insurance requirements. HUD limits Borrowers’ exposure as follows:

   • Deductibles may not exceed the greater of $50,000 or 1% of the insurable value for any particular building up to a maximum amount of $250,000.

• The Borrower must purchase casualty insurance in an amount that equals or exceeds any applicable co-insurance requirement. This limitation prevents Borrowers from purchasing insurance policies that require Borrowers to pay a share of damages on partial claims (i.e. claims for less than total losses). A co-insurance requirement is expressed as a ratio or percentage that the maximum insured loss for any casualty event bears to the aggregate of insurable values for a property. The maximum insured loss is also commonly called the “face amount” of the insurance policy and is the insurer’s maximum obligation for damages from any casualty event. Recognizing

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that total losses are quite rare, especially for multi-building properties, Borrowers often seek to reduce premium costs by reducing the face amount of insurance purchased. A co-insurance clause requires Borrowers to share in any loss if the face amount of insurance purchased is less than the co-insurance requirement. A co-insurance requirement typically but not always imposed by insurers is 80%, meaning the face amount of insurance purchased should equal or exceed 80% of insurable values. With this co-insurance requirement, if a Borrower purchases a face amount of insurance which is 65% of insurable values, then the insurer’s obligation to pay any claim will be limited to 65% of the claim, leaving 35% (plus any deductible) to be paid by the Borrower. If the Borrower purchases a face amount equal to or exceeding the co-insurance requirement, then the insurer is obligated to pay 100% of any claim (less any deductible) up to the face amount of the policy.

4. Exceptions. In some circumstances such as large properties with multiple buildings and properties included in a portfolio with multiple tiers of casualty loss coverage, a waiver of the 80% of insurable values minimum may be considered provided that the Lender demonstrates the adequacy of coverage in light of possible casualty events and that the Borrower is not obligated to share in losses arising from partial claims.