Is Your HOA Properly Covered for Losses From Dishonest Acts?

Because homeowners associations are controlled and operated by part-time volunteer members who serve as officers and directors and unrelated third-party mangers that are hired to provide management services, they are especially vulnerable to losses that result from the dishonest acts of these people. The risk of becoming a victim of a dishonest person who performs services for a homeowners association is compounded by the fact that there are substantial amounts of cash that flow into the association’s bank account every month with very little oversight as to what happens with those funds. Thus, for those people who are vested with responsibilities that provide access to the cash receipts of homeowners associations, there is opportunity to misappropriate funds. Recognizing this particular vulnerability of homeowners associations, state laws and association governing documents commonly include provisions that mandate the purchasing and maintaining of “fidelity insurance” by the association.

Fidelity insurance is insurance that is purchased by the association to protect against losses that result from “employee” theft. Typical insurance policies define an “employee” as an individual that is directed and controlled in the performance of their services and who is compensated directly by salary, wages, or commissions. Because the volunteer officers and directors, and the third-party property managers that they retain, are not “employees” under the typical definition of an employee, it is crucial that a homeowners association’s fidelity insurance policy contains language that expands the definition of “employee” to include officers, directors, committee members, and management company agents, bookkeepers and anyone else who has access to the association’s funds.

Losses that result from employee dishonesty are not always covered by a homeowners association’s master insurance policy and, in order to have the necessary coverage to protect against employee dishonesty, it may be necessary to purchase a separate policy that provides such coverage. Additionally, prior to purchasing the coverage, the association’s governing documents and state statutes should be reviewed to determine if there are minimum amounts of coverage that must be obtained. Aside from complying with the required minimum amounts of coverage, the association should have fidelity insurance limits that are sufficient to cover an amount that is equal to 100% of the association’s reserves plus three months of normal assessments. These amounts should also be reviewed annually and adjusted as needed to cover changes in the reserve balance.

Because not all insurance policies are the same, it is possible for a homeowners association to unknowingly purchase a fidelity insurance policy that contains the standard definition of an “employee” and not discover the error until after a loss has occurred and a claim is denied by the insurance carrier due to lack of coverage for the acts of the officer, director, committee member, property manager, or other person that had access to the association’s funds. To avoid the risk of not being properly covered when a loss occurs, association directors should use insurance agents who are experienced in placing insurance for homeowners associations and, in particular, fidelity insurance. In addition, a copy of the actual insurance policy that is to be purchased should be carefully reviewed by a competent person authorized by the association’s board of directors to confirm the coverage is as needed. Because insurance policies can be extremely confusing, it is a good practice for the association’s directors to obtain assistance from legal counsel for the review of the policy. Furthermore, the time to review the policy is before it is purchased.

Ironically, despite the importance of knowing exactly what is and is not covered by an insurance policy before it is purchased, rarely does that happen. In the typical scenario for purchasing insurance, a representative of the homeowners association contacts an insurance agent to inquire about the desired coverage. The agent then obtains a few different quotes for the coverage from different insurance carriers and presents them to the client for comparison and a decision on which carrier to go with. The information that is presented to the client for consideration typically consists of a general description of the type of coverage, limits of coverage, deductibles, and premiums. Based on this limited information, and without ever seeing the language that is contained in the actual insurance policy, the client instructs the insurance agent on which policy to purchase. The agent then obtains a payment from the client in order to bind the coverage. Within days or weeks of completing the purchase of the insurance, the client receives the actual insurance policy in the mail, casually looks over the policy (or not), and files it away without ever really studying the language in the policy. If all goes well, there are no losses suffered that would necessitate the submittal of a claim on the policy to the insurance carrier. Because homeowners associations are vulnerable to losses caused by dishonest people that they rely on, things do not always go as expected, and the possibility of having to submit a claim against the fidelity insurance policy becomes a reality. A representative of the homeowners association then notifies their insurance agent, or the insurance carrier of a claim, and subsequently learns for the first time when the carrier denies the claim, that the association did not have proper coverage for the loss that has been incurred. Frequently, the reason for the denial of coverage is based on a lack of coverage for the acts in question or the person who committed acts, or specific exclusions from coverage that are detailed in the actual policy.

To avoid a potentially devastating loss that is not covered by insurance, homeowners associations must obtain and thoroughly review a “specimen” insurance policy prior to purchasing the desired policy. A “specimen” policy is a blank policy that contains all of the actual policy language, including definitions and exclusions. By comparing the language in the specimen polices provided by different carriers, an informed decision can be made on the appropriate policy to purchase. If an insurance carrier will not provide a specimen policy for review prior to purchasing the policy, that company should not be considered. After a decision has been made and the policy has been purchased, the actual policy that is received from the insurance carrier should then be compared to the specimen policy that was reviewed to confirm that they are the same.

Homeowners’ association directors have legally imposed duties and responsibilities concerning the proper management of their association. Those duties and responsibilities include making sure that the association is covered by appropriate insurance, which at a minimum should include all insurance that is mandated by the association’s governing documents and applicable state laws. To fulfill those duties and responsibilities, association directors should familiarize themselves with the limitations and exclusions contained in the association’s insurance policies by having qualified people perform periodic insurance policy reviews and audits. If the association does not have the required insurance coverage, appropriate action should be taken to obtain it as soon as possible.