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Real Estate Insurance and Risk Management

First, some statistics. In the summer of 2005, the median price of a home rose nearly 15 percent from the year earlier, in some markets, much more. Lenders lowered required credits scores (FICOs), waived some documentation requirements, and raised the debt allowance to 45 percent of income. Some reports estimate that interest-only loans now make up 30 percent of all new mortgages. Nearly 35 percent of mortgages are now ARMs (Adjustable Rate Mortgages). Since June 2004, the U.S. Federal reserve has raised rates 11 times.

What all these numbers suggest is that real estate investments have seen phenomenal growth in recent years. But with rapid increase in prices always comes increased risk. The higher the value of an asset the greater the potential for loss. Fortunately, for every form of risk there's now an accompanying type of insurance.

The most common forms that benefit the investor/owner are title insurance and liability insurance.

Title insurance is designed to cover any lapses that may have occurred during the title search, prior to closing. Title companies search databases of public record and other sources to ensure a property is legally free of encumbrances. I.e. title can be legally passed to the new owner.

But like any human research effort, time and resources are limited and errors can be made. Public records databases are imperfect and title companies, though rarely, can fail to uncover a past tax lien or miss the fact that the adjoining strip of land is actually part of the adjacent property.

Title insurance covers any potential economic loss that results of these errors, up to a specified limit.

Liability insurance is intended to cover injuries to another party occurring on or as a result of using the property. When a salesperson or visitor steps onto the property and falls from a front deck because of a loose board, or any of a thousand other causes, liability insurance pays for medical bills, settlement of suits, etc. Again, up to a contractually specified limit and for a normal range of events. What constitutes 'normal' is what lawsuits are all about.

More extensive, and more expensive, forms of insurance are available for the dizzying variety of risks possible. Hazard insurance covers earthquake, tornado and hurricane, flooding, fire (natural), and dozens of other disasters outside human control. Damage from wind or freezing can be covered, too.

Alongside 'natural disaster' insurance are policies to cover man-made events: chemical spills, human caused fires, electrical failures, and on and on, endlessly. Insurance can cover damage or loss from vandalism or theft, faulty plumbing or wiring, even large appliance failure.

For landlords there are additional policies to cover the risk of rent interruption from non-payment, damage making the property uninhabitable, or abandonment.

Naturally, all these insurance policies come with a price, which varies according to amount covered and deductible desired. They're also invariably accompanied by limitations that restrict payment — for zoning variances, environmental conditions, negligence, and a host of other circumstances. As with any investment, shop around — you're not required to use any particular company the agent or title company recommends.

You are required, though, to get one form of insurance that doesn't benefit you at all. If you acquire a loan to finance a property purchase, the lender will require mortgage insurance — which pays the lender, not you, in the case of default or disaster.