Insurance and My Illegal / Non-Conforming Suite – Am I Covered?

Many property investors are able to increase monthly cash-flow from a property by adding an additional suite (such as in the basement). Given the significant increase in property values, sometimes the additional suite is the only way to obtain positive cash-flow. Interestingly, many property investors develop these suites AFTER the property is acquired – and, although the investor is always worried the suite will be shut down by the municipality, the investor fails to address an equally important issue – insurance.

Typically the property insurance was established prior to the date of possession at the request of the lawyer. The lawyer told you something about needing insurance for the mortgage company – so you found the best deal you could. Although this article won’t go into too many intricacies of property insurance and the law, it will point out a couple of issues that you should discuss with your insurance broker and even your lawyer. It will cover unauthorized suites – but also, in some areas, applies to all of your other suites.

Is the Suite Permitted?
The purpose of this article is not to determine the validity of a suite. However, most property investors are aware of local zoning restrictions and by-laws affecting rental property. Firstly, a generalization on the terminology. Many municipalities call these additional suites “illegal”, “unlawful”, “non-permitted” or some such phrase meaning the suite should not be allowed. For simplicity, this article will simply refer to these suites generally as “unauthorized”.

Why should I notify my insurance broker about an unauthorized suite?
As discussed in this article, there are several reasons. As a starting point – and ignoring for a moment whether the suite is unauthorized or not - if your insurance policy covers you for “loss of rental income” – do you not want to be covered for the extra income derived from the extra suite? Failing to tell your insurance broker about the extra income is tantamount to insuring only ½ of your legal side-by-side duplex!

Further, even if you do not have loss of income coverage, if you have not informed your insurance broker of the development of the suite (the basement for example), you may not have adequate coverage to replace that development if it is destroyed.

What is my insurance policy – and it is really MINE?
Generally, an insurance policy is nothing more than a contract to provide you coverage if certain events occur (usually referred to a “perils”). Many of the comments in this article are dependent on the words of the contract – and thus the reason you should explore your specific contract with your broker and lawyer.

It is important to note that when you take out a standard insurance policy and you have a mortgage – you are really taking out TWO policies.

Yes, part of the policy you acquire is for your benefit – but in addition to that, you are also acquiring a policy for your mortgage company.  When you acquired the property, your lawyer would have received a “binder letter” showing that you had insurance and that the policy complied with the requirements of your mortgage company.

Typically, the mortgage company will require that your policy is “replacement cost” and also that the binder letter contains the “Standard Mortgage Clause” protecting the lender. This Standard Mortgage Clause is not covered in detail here, but suffice it to say that, even if you are not covered under your insurance policy (i.e. if it is declared void), your mortgage company will be by this separate policy under the Standard Mortgage Clause.

What Does Insurance Cover?
Generally, insurance covers property damage and liability protection if there is damage to a person. As you are likely aware, when your broker sold you the policy, there was something about an amount to cover the property – and an amount to cover you if you were “liable” for some injury to a person. It is highly recommended that you explore what is covered under your policy with your insurer – when your tenant causes damage to the property or if a visitor of your tenant is injured on your property.

Typically, your insurance policy will cover you if you are found to be liable. However, there are a few considerations. Firstly, what is the “limit” of your coverage and also, have you done anything to void your policy. Again, the intent is to not cover the business implications of insurance – but another reason to speak to your insurance broker regarding an unauthorized suite (or authorized for that matter!) is to make sure you have enough liability insurance if something goes wrong.
Remember, you potentially have doubled the amount of any claim if something drastic occurs and you are found at fault. You now have TWO sets of tenants that may have a claim against you. Further, your risk has also potentially increased by the visitors to each set of your tenants. Quite simply, you may want to double your liability coverage – just as you would if you had TWO separate rental properties.

As an aside, it is imperative that your tenants have their own insurance – but that is for another article!
Additionally, if you have several properties – you may want to discuss a “blanket”, “umbrella” or “business” policy to protect you from liability.

Does the Unauthorized Suite Void My Insurance?
Again, you must refer to the words of your contract. However, based on typical insurance contracts, your actions that are not illegal will NOT void your policy. This means that – although you are in violation of the municipal requirements for housing (such as zoning), your insurance policy will still cover you if something happens (assuming it would have covered you in the first place!). Again, this is a topic to discuss with your insurance broker. Suffice it to say, that you can’t do extreme things (illegal) - like burn your own property down and benefit - but minor infractions typically do not void your policy.

During your discussions with your insurance broker, be prepared that your broker may ask who developed the suite and whether there were building permits and approvals. Your liability may increase if you have not obtained building permits – as you may be found legally liable if you have done something that a “reasonable” person would not have done. As an example, if you wire the basement suite with extension cords (instead of normal electrical wire), you have most likely increased your legal liability!

Further, it is highly recommended that you comply with at least minimum standards applying to rental properties – as the writer suggests that any reasonable real estate investor would do so. For example, if the investor’s failure to comply with minimum safety standards is found to be the cause of the damage incurred (such as failure to provide adequate exits in a basement suite), the investor may be found liable.

Conclusion
It is important that you discuss your insurance requirements with your broker when you develop a suite in a rental property – regardless of whether it is permitted or not. Your broker will discuss your specific contract with you and determine the limits of insurance that you will now need. Although your insurance contract will not likely be void simply because the suite is “unauthorized” – you will want to make adjustments to your policy – as the property replacement cost has increased and so has your potential liability as you are now dealing with multiple tenants.