It doesn’t matter whether the trust you manage owns commercial or residential real estate—the challenges are the same. The property’s location, value, and construction only determine the extent of these challenges. In this article, we’ll review the potential roadblocks a trustee of a trust-owned property may face and how to handle them.
A Challenging Property Insurance Market
The property insurance market has been getting more challenging in recent years. According to the 2023 Policygenius Home Insurance Pricing Report, US insurers paid out $99 billion in claims related to natural disasters in 2022. As a result, premiums rose by an average of 21% from May 2022 to May 2023, dwarfing the 12% increase during the previous year.
Rates increased by an average of 35% in Florida, the most of any state. Hurricane Ian, which hit in late September last year, turned out to be the costliest hurricane in the state’s history. In Idaho, where many homes are vulnerable to wildfires, owners paid an average of 31% more in insurance than in 2021. Colorado, South Dakota, Louisiana, and Texas also saw marked rate increases as residents confronted losses from natural disasters combined with fewer insurance options. In California, insurance companies are pulling out, declining to not issue new home insurance policies.
Other factors impacting the property insurance market include:
- Inflation. Rising inflation rates have affected property valuations as well as construction and labor costs, leading to higher insurance premiums.
- Reinsurance Market Impact. Extreme weather and inflation have led to a strained reinsurance market, with reinsurers increasing prices and insurers passing these costs to policyholders.
- Outdated Property Valuations. Insurance carriers are correcting undervalued properties, leading to higher premiums upon renewal.
- Supply Chain Disruptions. The cost of building materials has surged due to supply chain disruptions, which, in turn, has raised repair and rebuild expenses and contributed to higher insurance costs.
A Balancing Act for Insureds
Overall, insureds must balance the affordability of insurance with the level of risk they are willing to assume. This area is where trustees need to pay close attention.
|Trustees are responsible for managing assets (including protecting property) as they relate to the fiduciary duty of care. However, what was once a relatively benign decision to purchase property insurance is now much more complicated.|
Trustees must decide if and how much insurance to purchase, and, if a claim arises, determine the estimated impact on the assets under administration. This responsibility can seem like a no-win situation.
While there may not be an affirmative concept of materiality relative to trustees, an insurance decision may be material to the estate if a reasonable person would consider it an investment decision. This determination would fall within the fiduciary duty of care role of the trustee.
Most trustee liability insurance policies have an exclusion for the failure to effect or maintain insurance. Historically, that exclusion has covered situations when the trustee didn’t renew an insurance policy because they were unaware of the policy, thought it was someone else’s responsibility, or various other situations involving a mistake.
Evaluating All the Options
Today, that exclusion is more complex. Imagine a situation where a trust owns a $20 million property in a high-risk area. The property may be uninsurable in today’s market, or the trustee may only be able to purchase partial insurance. Another possibility is that the premium has become so high that the trustee must decide whether to purchase property insurance at all.
It’s critical to keep in mind that a loss—even a partial loss or a coinsurance clause—could significantly impact the amount of assets available to beneficiaries and result in a lawsuit alleging negligence in the trustee’s decision-making process.
The expectation is that the trustee evaluates all insurance options and makes the most informed decision possible. To meet this expectation, the trustee should consult the investment advisors to determine whether there is enough liquidity in the investment portfolio to withstand this type of loss. The decision should then be clearly communicated to the trust beneficiaries. Following this process will help make the trustee defendable in the event of a claim.
For more about how property insurance may impact your exposure to litigation as a trustee, reach out to your insurance broker.
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