Risk Management for Real Estate: Insurance Requirements

Working as a real estate agent or broker comes with an inherent amount of legal risk. That's why real estate professionals need insurance. Learn about risk management for real estate and how much insurance you need.

Malpractice Liability Risks Faced by Real Estate Pros

The single greatest liability exposure most real estate agents and brokers face is for malpractice lawsuits by dissatisfied buyers or sellers. They could allege things like fraud, misrepresentations, negligence, failure to disclose and other violations of the agent's or broker's legal and fiduciary duties. Even if you're innocent, a malpractice lawsuit can cost hundreds of thousands of dollars.

If you're a sole proprietor or partner in a partnership, you'll be personally liable for malpractice lawsuits. You can avoid personal liability if you form a corporation or limited liability company LLC. But, not as much as you might think.

No limited liability entity protects you from personal liability for your own malpractice or other personal wrongdoing. If your business doesn't have enough assets to pay a judgment obtained against you, your personal assets are liable. Thus, your personal assets will always be on the line if you're being sued for malpractice. This is why you should always have errors and omissions insurance.

Example: Janet, a real estate broker, forms a corporation of which she is the sole shareholder. She represents a client in the sale of a home. After a sale closes, the buyer discovers that severe building defects were not disclosed. The buyer sues Janet and her client, the seller, for fraud. Janet is incorporated but she could be held personally liable (along with her corporation) for any damages caused by her alleged fraud. Both Janet's personal assets and those of her corporation are at risk.

As a rule, a real estate broker is legally responsible for the actions of the real estate agents. Having an LLC or corporation as an entity may help limit the broker's personal liability. This is as long as the broker wasn't personally involved in the alleged wrongdoing.

Many states require real estate brokers have malpractice insurance to obtain this limited liability. Other states limit the amount of limited liability incorporating can provide a broker.

The rules vary from state to states. You should learn yours to determine if incorporating or forming an LLC makes sense to limit your personal liability for others' malpractice.

Liability for Negligence

Malpractice isn't the only type of liability you need to be worried about. Other forms of liability include:

• Premises liability: Responsibility for injuries or damages that occur at your office or other place of business.
• Infringement liability: When someone claims that you have infringed on a patent, copyright, trademark or trade secret.
• Employer liability: Liability for injuries or damages caused by an employee while he or she was working for you.

Forming a corporation or LLC to operate your real estate business will relieve you from personal liability for negligence by others. For example, incorporating may protect your personal assets from lawsuits by people who are injured on your premises due to no fault of your own. However, remember that you're always personally liable for your own negligence or intentional wrongdoing. This means that you can be personally liable under a negligence theory for all the different types of lawsuits outlined above even if you have a corporation or LLC—for example:

• An employee accidentally injures someone while running an errand for you. The injured person sues you personally for damages claiming you negligently hired, trained and/or supervised the employee.
• A real estate photographer sues you, claiming you've infringed upon a copyright when you posted one of their photos to your website. Even if you've formed a corporation or LLC, you can be personally liable for such claims.
• The person in charge of your payroll fails to properly withhold and pay income and Social Security taxes for your employees. You can be personally liable even if you weren't personally involved.

In all these cases, forming a corporation or LLC will prove useless to protect you from personal liability.

Liability Insurance

Liability insurance protects you when you're sued for something you did (or failed to do) that injures another person or damages property. It pays the legal fees to defend you against a lawsuit as well as any settlement or judgment against you up to the policy limit. Liability insurance also pays an injured person's medical bills. In our lawsuit-happy society, such insurance is often a must.

There are two different types of liability insurance:

• general liability insurance, and
• professional liability insurance.

You need both types of coverage.

General Liability Insurance

General liability insurance provides coverage for the types of lawsuits any business owner could face. For example, this type of insurance protects you if a client visiting your office slips on the newly washed floor and breaks an arm, or if you knock over and shatter an heirloom vase while holding an open house.

If you already have a homeowners' or renters' insurance policy, don't assume you're covered for these types of claims. Such policies ordinarily don't provide coverage for injuries to business visitors unless you obtain and pay for a special endorsement.

Luckily, general liability insurance is not terribly expensive. You can usually obtain it for a few hundred dollars per year. You can purchase coverage:

• as part of a package policy such as a BOP, or by obtaining a separate general liability insurance policy known as
• a "commercial general liability" (CGL) policy, which may cost the most but will give you more coverage.

Professional Liability Insurance

General liability insurance does not cover professional negligence: claims for damages caused by a mistake you made or something you failed to do when performing professional services. You need a separate professional liability insurance policy, also known as "errors and omissions," or E & O, coverage. Some states require that real estate licensees have this type of coverage.

Your E & O insurer will defend you against such claims and pay any damages or settlement up to the amount of your policy limits. However, be aware that most policies provide coverage only for negligent, non-intentional acts, not deliberate, knowing, or intentional acts or wrongs. Thus, for example, you would not be covered against claims of intentional fraud or criminal acts.

There are two types of E & O coverage involved. First, the real estate broker or brokerage firm should have its own policy protecting it from claims made against the real estate agents who work for the broker. The individual agents should also have their own coverage. Alternatively, the broker could offer a group policy in which the agents may participate, with the cost split among all the agents who work with the broker. In many states, individual coverage is not available to real estate agents, and they must obtain coverage through a group policy obtained by the broker.

Such insurance tends to be expensive, ranging from several hundred to several thousand dollars per year. The cost depends on many factors, including the amount of the deductible, the policy limits, the size and claims history of the business.

Umbrella Coverage

Liability insurance always comes with a policy limit—the maximum amount the insurance company will pay to defend the insured and pay any damages. Policy limits of $500,000 to $1 million are common. However, it's not uncommon for the cost of lawsuits to exceed such limits. That's why there is another type of liability insurance called "umbrella coverage."

An umbrella policy is designed to supplement regular liability insurance. It protects you if you suffer a major liability loss that exceeds the limits of your regular liability policy. For example, if you have a general liability insurance policy or E & O policy with a limit of $1 million and are sued for $2 million and lose, an umbrella policy will pay the $1 million not covered by your regular liability policy.

Umbrella coverage is relatively inexpensive because it merely supplements your regular insurance. You must have a regular liability policy before you can obtain umbrella coverage. There are no standard umbrella policies. Ideally, you want a policy that pays for all defense costs over your regular policy's limits, with no cap. Your regular liability coverage and umbrella coverage should run concurrently; in other words, they should cover the same time periods. This avoids unintended coverage gaps.

Car Insurance

If, like most real estate professionals, you use your automobile for business as well as personal use, you need to be certain that your automobile insurance will protect you from accidents that may occur while on business. Review your policy and discuss the matter with your insurance agent or auto insurer. You may need to purchase a separate business auto insurance policy or obtain a special endorsement covering your business use. Whatever you do, make sure your insurer knows that you use your car for business purposes (in addition to personal use and driving to and from your office). If you do not inform your insurer about this, it may cancel your coverage if a claim occurs that reflects a business use.

If you keep one or more cars strictly for business use, you will definitely need a separate business automobile policy. You may be able to purchase such a policy from your personal auto insurer.

To view the original article, visit the MileIQ blog.