Newbie help needed! Liability Insurance considerations.

[Andrew B.]

Hi BP! After purchasing a property it's my understanding standard homeowner insurance is not sufficient to cover a landlord in terms of liability. In the interest of qualifying for residential financing it seems an LLC is not a great option for asset protection when starting out. With that in mind general liability insurance appears to be the best option.

What would be a good level of protection when starting out (1/2 million)?  How should that protection be modified as you start to add multiple properties to your portfolio (umbrella policies/etc.)?  Any input you could provide on the subject of would be greatly appreciated.

[Troy Zsofka]

@Andrew B. -

I also am not an attorney and only sharing my opinion. However, I have had many conversations with insurance agents over the years, and one in particular has always been incredibly knowledgeable.

His take on liability coverage makes a lot of sense and is based on the potential liability exposure (as it obviously should be). As an example, my properties are all single family and duplexes where the tenants are responsible for snow removal. I also require each tenant to carry renter's insurance with a minimum of $300K liability coverage ($500K if they have a dog), naming my property management company and the property's ownership entity as additional insureds. This effectively mitigates the need for a large liability limit on the property insurance so long as you are doing a good job with property upkeep and your other responsibilities. Conversely, if you have a multi-family where you are responsible for snow removal, ice control on steps, etc, there is much more potential liability exposure. In my case, if someone slips on ice, the renter's insurance will step in because the ice was the tenant's responsibility. With a multifamily, if someone slips and falls on ice, there is no renter's insurance to take some of the heat.

All that said, I carry $1MM per occurrence anyway, for a couple reasons:

1) It is not a lot of money to go from $500K to $1MM. I also mitigate the additional cost by carrying a larger deductible on the property coverage. I can be overly thorough sometimes so I calculated the expectation of loss based on national statistics regarding type, frequency, and severity (average payout) of claims. I determined that, in the long run (assuming your properties are in good condition), you are better off with larger deductibles because the amount you save in premium should be more than enough to cover small occurrences that are below your deductible. I have always felt that insurance should only be used to protect against losses that otherwise can not be absorbed, and the data tends to agree (obviously, otherwise insurance companies would lose money). Several thousand dollars in uncovered repairs is a cost of doing business that isn't going to have much of an affect in the long run (especially if you're saving it in lower premium for the higher deductible); whereas several HUNDRED thousand dollars in uncovered liability judgement is going to hurt, really bad.

2) Once you grow to a certain level, you become more of a target for lawsuits. Ask any attorney who will give you an honest answer, and they'll say that a litigation lawyer is more likely to file a nuisance suit with little to no merit against a defendant with significant assets, than to file a legitimate suit with demonstrable merit against a defendant with little to no assets.

Bottom line, in our super-litigious society, I think it's worth spending a few additional bucks to have plenty of liability coverage. That way, if someone does try to get rich off your hard work, it will be your carrier and their formidable team of lawyers that will be dealing with it, not you racking up legal fees and stress.

Happy investing,

Troy