Knowledge Vacancy: When Clients Get Bad Insurance Advice

Lawyers are reckless.

Don’t get me wrong—I didn’t say they don’t know the law or that they aren’t necessary. They just don’t know insurance.

But not knowing insurance isn’t even necessarily the problem. The problem is making recommendations without understanding the insurance ramifications.

Here’s a true story from the Big “I” Virtual University’s Ask An Expert service that proves the point:

“One of our elderly homeowner insureds transferred ownership of his home to an LLC in September 2017. Four months later, on Jan. 11, 2018, before any changes were made to the policy, the home burned down—a total loss.

The insurance carrier is investigating under a reservation of rights because it claims the named insured, the individual, no longer has insurable interest in the property. The carrier has agreed to cover the contents, but may not cover the dwelling.”

Undoubtedly, this recommendation was made by an attorney—probably for estate tax purposes. The problem with this recommendation stems from the fact that the attorney apparently did not inform the homeowner that transferring ownership jeopardized his homeowners coverage. Most likely, the attorney didn’t know the insurance ramifications.

In this case, the insurance carrier was right to deny the claim for two reasons:

The named insured, the individual, no longer owned the home and thus no longer had insurable interest. The owner became the LLC.

Second, there is currently no way to cover an LLC, corporation or other such legal entity under a homeowners policy. Trusts are the only non-natural person currently insurable by a homeowners policy.

People Defined

Under the law, two types of people exist: natural persons and legal persons. Natural persons are flesh-and-blood individuals; legal persons are created by filing legal documents such as articles of incorporation or organization. Natural and legal persons have the same rights under the law, including the right to sue, be sued and own property.

But many people forget one key point: A natural person is not also a legal person, and a legal person is not also a natural person. This simply means that just because a person owns 100% of a corporation’s stock, that does not equate them with the corporation. They are still separate persons under the law.

In the above scenario, even though the individual was likely a member of the LLC—and maybe even the only member—that does not equate him with the LLC. As a separate entity, the LLC owned the dwelling. The individual no longer held ownership or had legal interest.

Homeowners Policy Eligibility

A second reason the carrier appears to be correct in its denial is eligibility. Specific guidelines may apply to each of these eligibilities, but here is a general list of eligibility requirements.

A homeowners policy can be written for:

  • The owner/occupant(s) of a 1-4 family dwelling used exclusively for private residential purposes.
  • A purchaser/occupant who has entered into a long-term installment contract for the purchase of the dwelling, although the title remains with the seller and does not pass to the purchaser/occupant until all the terms of the installment contract have been satisfied. The seller cannot act as a mortgagee.
  • The occupant of a dwelling under a life estate arrangement.
  • A dwelling in the course of construction when the policy is issued only in the name of the intended owner/occupant.
  • One occupying co-owner of a 2-4 family dwelling when two or more apartment units in such dwelling are occupied by co-owners, each occupying distinct living quarters with separate entrances.
  • The occupant of a house in a trust arrangement that meets specific requirements. Endorsements are used for this arrangement.

Note that none of these guidelines allow for coverage of an LLC, corporation or other non-natural entity, other than a trust.

In the example case, the dwelling is not eligible for a homeowners policy as of its September 2017 transfer to the LLC.

The Sad Facts

Couple the fact that the named insured was no longer the owner with the fact that an LLC is not eligible for a homeowners policy, and there is only one conclusion: the carrier appears correct in its property claim denial.

Upon the dwelling’s transfer to the LLC, a landlord’s policy using the DP program or a lessor’s risk only policy should have been written to cover the dwelling and the LLC’s liability exposure.

But we cannot expect a homeowner to know to do this unless they are advised by a trusted professional [see sidebar]. The attorney or financial planner should have told the insured that transferring ownership essentially negated his homeowners policy, then advised him to purchase coverage in the name of the new owner—the LLC. The former owner could still have insured the contents and his personal liability on an HO-4.

Fortunately, in this case, the carrier did agree to cover the contents. But this is not the only example of lawyers creating coverage gaps. Problems can also occur when tax attorneys and CPAs recommend changing the entity type. The issue of ownership changes creates the same problem.

As ridiculous as it sounds, never assume the “owner” actually is the owner—ask specifically who owns the property. With this simple question, an agent may learn that the “person” owning the property is not the person named on the policy. If this scenario comes to light, make changes on the policy.

Attorneys don’t have a clue how to address the insurance issues. Agents must be ready to clean up the mess their recommendations leave behind.

Chris Boggs is executive director of the Big “I” Virtual University and an IA contributor.

A Matter of Trust

Consumers depend on insurance agents to be trusted advisers. The insurance-consuming public does not know, and cannot be expected to know, anything about insurance—that’s the agent’s job. It’s another reason why direct purchase of insurance is detrimental to the buyer.

When the insured calls to say, “We did this,” or “If we do this, what do we do?” agents must know answer to the insured’s question. If the insured calls you to say, “We just transferred the title of our house to an LLC,” you need to understand the legal ramifications (insurable interest) and related eligibility problems.

But an agent can’t act until the situation is known. Agents are not charged with being mind readers. They are, however, charged with knowing their products.

Know the questions you need to ask—and know where to find the answers. —C.B.