Now currently FHA mortgage insurance is MANDATORY. 

I've upped my umbrella insurance as well.I live in Washington State. 

What about insurance costs-where do they fall?

4) what obligation do i have to fix it? 

Become additionally insured on their general liability insurance policy, and for extreme measure, ask to get a performace bond in the beginning.

You will also likely not be able to get insurance or be in violation of your insurance with a illegal rental.

But I do this knowing the AirBnB insurance is not part of the deal so there has to be either short-term rental insurance in place or homeowner's insurance for 30+ day rentals. 

I used to do thousands of them back in the day for banks, insurance companies, asset companies etc.Haven't done it in a long time.The experience I can mention is the person you are wanting a value from doing  a bunch of BPO's already or mainly selling properties and making a commission?

If someone goes there and gets hurt, they can sue you, but your insurance company will take care of the defense.

Also, the quitclaim deed may void the title insurance policy that you got at closing.