Is It Appropriate to Reserve for Insurance Deductibles?
Many associations choose to obtain insurance against a possible significant loss: earthquake, flood, wind, or other major catastrophe. Due to the nature of this type of insurance, the deductible is often very large. While insurance is expected to cover the majority of a loss, conservative associations often ask if it is appropriate that they have a Reserve component for the size of their catastrophic insurance deductible.
For a complicated question such as this one, it is important to go back to the basics. National Reserve Study Standards dictate that any potential expense meet the following four-part test to be funded through Reserves:
- Common area maintenance responsibility
- Useful Life limit/cycle
- Predictable Remaining Useful Life
- Above a minimum threshold cost of significance.
This means major, association-responsibility, cyclical, predictable projects should appear in the Reserve Study. Since catastrophic events do not have repeatable life cycles (intervals) and since the next occurrence of such an expense is not predictable, catastrophic event insurance deductibles fail test #2 and #3, making them inappropriate for Reserve component designation.
Insurance Deductibles are Not Predictable
Back to the big picture. The Operating Budget is where an association handles its ongoing daily, weekly, and monthly expenses. The Reserve Budget is where an association prepares itself for major predictable repair and replacement projects. Insurance and special assessments are the normal ways an association handles unexpected large “surprise” expenses.
It may seem like a good idea for an association to set some cash aside for such a “catastrophic” event. But setting aside Reserves for what is by definition an unpredictable expense goes against National Reserve Study Standards. Most associations simply cross their fingers and trust the odds that they will avoid the catastrophe entirely, special assessing as necessary to meet the insurance deductible if that unfortunate day arrives.