As real estate investors ourselves, we like insurance. We use it for our personal investments and frequently advise our clients to do the same. An insurance policy can help you limit your liability, and it’s always a good idea to get an agent to explain your best options. However, it’s important for investors to understand that there is an appropriate time and place for insurance. Let’s look at what insurance is, what it isn’t, and some examples of the role insurance plays in your asset protection strategy. What Is the Difference Between Insurance and Asset Protection? Insurance is great to have, but it should not be confused with an actual asset protection strategy. While it can certainly protect you in specific situations, insurance will not effectively prevent the vast majority of lawsuits that most real estate investors face. Thinking of insurance as a component of your asset protection strategy is fine, but it is not a substitute for a thorough asset protection plan. It’s important to realize that the insurance companies are running a business. As a result, if you make a claim for something that is not covered, you may not just be denied. They may decide you are too big a risk to have as a client and drop you. Real Estate Insurance’s Benefits and Limitations An investment property insurance claim usually results from a “slip and fall” on a property or something else you would normally characterize as an accident. Typically, this is what your insurance is willing to cover. But the definition of “accident” is something that insurance can and will debate with you. Spoiler alert: the insurance company usually wins. Let’s take a look at some examples that show how insurance claims work in the real world. Example 1: Insurance Working for Its Intended Purpose Let’s imagine for a second that you own a condo in New Jersey. You bought the property at a nice price and hire some contractors to fix the place up. One night, a storm hits. Your contractor comes into work the next day to replace the flooring, and slips on the icy sidewalk. He sprains his ankle, but one Urgent Care visit and a few days later, he is back at work. This is the exact type of situation a general insurance policy is likely to cover. Insurance in this case keeps you from being personally on the hook for the contractor’s medical expenses and other costs of the injury. In this case, insurance worked exactly as it was supposed to. Our next example looks similar, but has a completely different outcome because of how insurance works. Example 2: When Insurance Isn’t Enough Suppose you own a two-story duplex. Prior to making the purchase, you had a friend do the inspection of the property to save money. You upgrade some appliances, but otherwise rent it out as you bought it. Your tenant for the upstairs unit, Sabrina, is a 55-year-old teacher. One evening, Sabrina is taking a shower and the tile floor splits apart, and she comes crashing through to the first story. Sabrina is badly hurt and requires six weeks of hospitalization, multiple surgeries, and extensive physical therapy for the next year. Her doctors indicate that she may be permanently disabled. She is naturally extremely upset. You call your insurance company, who sends out an investigator to assess the scene. It turns out that your upstairs bathroom was missing a shower pan, which caused the floor to rot to the point that this accident was possible. Of course you never intended for anyone to get hurt, but the insurance company denies you coverage by claiming you were “grossly negligent.” Why? It was on you to get the inspection done and make the appropriate repairs that could have prevented the accident. At least, that’s their position. You will be seeing Sabrina in court soon, where she is now seeking a $750,000 judgment for her many expenses as well as her pain and suffering. Your insurance company won’t touch this situation with a ten-foot pole. This is far from the only situation where insurance won’t protect you. Some other scenarios you can’t expect insurance to cover include: Gross negligence on your part. Gross negligence is basically them saying, “You should have known this was an issue and fixed it. Because you didn’t, we aren’t paying.” Insurance companies will work surprisingly hard to make this point and exclude your coverage. Large judgments. A standard insurance policy will not cover a large judgement. Large claims in general. If your claim is too high, the insurance company will actively find a reason to deny your claim. Even umbrella policies with higher limits won’t protect you. Tenant disputes involving liability, discrimination, rent, evictions, etc. Financial disputes with contractors or vendors. You may be wondering what recourse you have if your claim is denied. Basically, your only option is to sue your own insurance company. So you’d have TWO expensive, stressful lawsuits on your hands, and the odds are not in your favor. Remember that these are big companies with deep pockets for extremely skilled attorneys. Your resources are better spent funding an asset protection plan before there’s a problem than fighting with an insurance company after the excrement hits the fan. Use Insurance in Conjunction with an Asset Protection Plan Insurance Should Be Your First Line of Defense. Common sense tells us that investors should protect themselves with an appropriate insurance policy for each rental property. Renting property that is not covered by insurance is extremely foolish at best, and at worst, illegal. If you were to experience a situation like the first example in this lecture without insurance, you could easily be personally liable for the entire affair and all of its costs. This could include medical expenses, lost wages, pain and suffering, and more. These bills can become astronomical, and insurance will indeed protect you in personal injury situations. Learn more about the appropriate use of insurance from our free educational resource on tenant injuries and landlord liability. You will have options when selecting your insurance policy. The best policy for you will depend heavily on your situation. For your convenience, we have made a handy list of essential questions to ask your insurance agent. Insurance Should NOT Be Your Only Defense. As you can see, insurance has some hard limits on what is and is not covered. Real estate investors should absolutely have insurance, but expecting it to provide total asset protection is like expecting a drill to do a saw’s job. Smart investors should incorporate insurance into a greater asset protection strategy that includes appropriate entities, trusts, and well-written contracts. We will explore these details later in the course. The takeaway for now is this: be proactive, not reactive. Don’t wait until you’re threatened with a lawsuit. Have a plan in place that includes insurance and more powerful defenses.