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Does Your Condo or HOA Need Crime Insurance?

Unfortunately, financial crime has been on the rise in condos and HOAs.  Over the past year, there have been numerous reports from around the country of directors, officers, and property managers of community associations embezzling funds.  Examples of alleged financial crimes against homeowners associations that have recently been reported in 2022 are as follows:

    • In Florida, several current and former members of the Hammocks Community Association were arrested and charged with racketeering, fraud, and theft for allegedly stealing over $2,000,000 from their homeowners association.
    • In Utah, a forensic audit revealed that a former treasurer took almost $250,000 from her homeowners association.
    • In Alabama, an HOA property manager was sentenced to 40 months in prison for stealing $1,400,000 from various homeowners associations.
    • In Colorado, an HOA property manager was sentenced to 37 months in prison for stealing more than $250,000 from various community associations.
    • In Indiana, an HOA property manager allegedly stole approximately $180,000 from her HOA clients.

Given that homeowners associations are nonprofit corporations, and in many cases, their sole source of income is through HOA assessments, it is important that community associations adequately protect themselves from large financial losses that could be financially devastating.  Accordingly, this article will discuss crime insurance, which is a critical tool in protecting a community association from theft by a director, officer, or property manager.

 

What Is Community Association Crime Insurance?

Crime insurance and fidelity insurance protects a community association from certain types of criminal acts.  Examples of claims that may be covered under a crime and fidelity insurance policy are:

    • Employee Dishonesty, such as theft, by board members, officers, committee members, employees, volunteers, bookkeepers, or property managers that have access to association funds
    • Forgery
    • Theft of personal property
    • Counterfeiting
    • Wire Fraud

By way of example, if a director, officer, or property manager made unauthorized cash withdrawals and embezzled funds from the community association, a crime insurance policy would reimburse the community association for its loss, and the insurance company would be responsible for attempting to recover any missing funds from the director, officer, or property manager through subrogation.  If a community association does not have crime insurance, and cannot recover stolen funds, it may lead to large unexpected additional assessments against the members and interfere with general community association operations.  Accordingly, a crime insurance policy is an effective way to ensure that a community association will recoup its fund immediately, as opposed to potentially having to obtain a civil judgment or criminal restitution against a potentially uncollectable wrongdoer.

Crime insurance is not always included in a community association’s master insurance policy.  Accordingly, community association board members should consult with their insurance agent to determine if they are adequately covered.  In some cases, the condominium documents will require a fidelity bond, as opposed to crime insurance.  However, coverage under a fidelity bond is typically narrower than under a crime insurance policy, as it typically only covers specific directors, officers, or a property management company.

 

Do Fannie Mae and Freddie Mac Require Condo Associations to Carry Crime or Fidelity Insurance?

In addition to protecting a community associations assets, it is also important to know that Fannie Mae and Freddie Mac require certain types of condominium associations to carry crime insurance to meet mortgage underwriting requirements.  While there are several exceptions, generally speaking, if a condo association has more than $5,000 in funds and more than 20 units, it will need to have crime and fidelity insurance to meet mortgage underwriting guidelines.

As a general rule, the crime and fidelity policy must provide coverage for dishonest or fraudulent acts for anyone that is responsible for handling association funds, including the property manager. The lending guidelines also indicate that a property manager should be covered by its own crime and fidelity insurance as well.  Fannie Mae and Freddie Mac also require crime and fidelity insurance coverage that insures the maximum funds that are in the control of the community association or property management company at any one time.

If certain financial controls are in place, the crime and fidelity coverage may be reduced to a minimum sum of three months of assessments on all units in the project.  Specifically, a condominium will still be warrantable under Fannie Mae and Freddie Mac lending guidelines if the following financial controls are in place:

    • Separate bank accounts are maintained for the working account and the reserve account, each with appropriate access controls, and the bank in which funds are deposited sends copies of the monthly bank statements directly to the HOA or co-op corporation.
    • The management company maintains separate records and bank accounts for each HOA or co-op corporation that uses its services, and the management company does not have the authority to draw checks on, or transfer funds from, the reserve account of the HOA or co-op corporation.
    • Two members of the Board of Directors must sign any checks written on the reserve account.

However, even if with financial controls in place, it is prudent to obtain crime insurance that would cover a complete loss of a community association’s funds, due to the potential financial impact and disruption to association operations.

 

Conclusion

Accordingly, it is important to have an independent CPA perform a review, or in some cases an audit, of the financial records of a community association on an annual basis, as often times fraud will continue unchecked for years at a time.  While the Michigan Condominium Act, MCL 559.157, permits condominium associations to vote to opt out of an annual audit or review, those that choose to do so, likely run a higher risk of experiencing a fraud event.  Accordingly, the costs that these condo associations may save on the front end, may end up costing them significantly more if a major fraud event occurs.

Finally, the Michigan Condominium Act does not mandate that a condominium association obtain crime or fidelity insurance.  Similarly, there is no Michigan HOA law that would require a homeowners association to obtain crime or fidelity insurance.  Unfortunately, the governing documents for many community associations indicate that crime and fidelity insurance is optional, as opposed to mandatory. While it would be nice if community association boards all voluntarily purchased crime insurance, wrongdoers are unlikely to purchase it, unless required, and other board members may view crime insurance as a “luxury” as opposed to a “necessity.” Accordingly, given that embezzlement may financially ruin a community association, the only way that community associations can truly protect themselves, is to update their master deed, bylaws, or declaration to mandate a minimum level of crime insurance, which would generally be in line with the Fannie Mae and Freddie Mac guidelines as discussed above.

Kevin Hirzel is the Managing Member of Hirzel Law, PLC and concentrates his practice on commercial litigation, community association law, condominium law, Fair Housing Act compliance, homeowners association law and real estate law. Mr. Hirzel is a fellow in the College of Community Association Lawyers, a prestigious designation given to less than 175 attorneys in the country. Mr. Hirzel has been recognized as a Michigan Super Lawyer’s Rising Star in Real Estate Law by Super Lawyers Magazine, a Leading Lawyer in Condominium & HOA law by Leading Lawyers Magazine, and as a Best Lawyer in Real Estate Law by U.S News and World Report’s Best Lawyers Publication. He represents community associations, condominium associations, cooperatives, homeowners associations, property owners and property managers throughout Michigan. He may be reached at (248) 450-0339 or kevin@hirzellaw.com.

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kevin@hirzellaw.com

Kevin Hirzel is the Managing Member of Hirzel Law, PLC. Hirzel Law has offices in Farmington, Grand Rapids, and Traverse City, Michigan with a fourth office location in Chicago, Illinois. Mr. Hirzel focuses his practice on condominium law, homeowners association law, and real estate law. He is a fellow in the College of Community Association Lawyers (“CCAL”), a prestigious designation given to less than 175 attorneys in the country. Mr. Hirzel formerly served on the CCAL National Board of Governors and is a former member of the Community Associations Institute’s (“CAI”) Board of Trustees, an international organization with over 40,000 members worldwide that is dedicated to improving community associations. Mr. Hirzel has been recognized as a Leading Lawyer in Michigan by Leading Lawyers, a distinction earned by fewer than 5% of all lawyers licensed in Michigan. He has been named a Michigan “Rising Star” in real estate law by Super Lawyers Magazine, a designation is given to no more than 2.5% of the attorneys in Michigan each year. Mr. Hirzel was also named as a “Go-To-Lawyer” in condominium and real estate law by Michigan Lawyer’s Weekly. Hirzel Law was also voted the best law firm in Metro Detroit in the Detroit Free Press Best of the Best awards. He is the Co-Chairman of the State Bar of Michigan’s Real Property Law Section Committee for Condominiums, PUDs & Cooperatives. Mr. Hirzel has authored numerous articles on community association law for publications such as the Michigan Community Association News, Michigan Real Property Review, Macomb County Bar Briefs and the Washington Post. He is also the author of “Hirzel’s Handbook: How to operate a Michigan Condo or HOA”, which is available for purchase on amazon.com. Mr. Hirzel has been interviewed on community association legal issues by various media outlets throughout the country, such as CBS, CNBC, Common Ground Magazine, Community Association Management Insider, the Dan Abrams Show on SiriusXM Radio, the Detroit News, Dr. Drew Midday Live on KABC Radio, Fox Business News, Fox News, HOALeader.com, the Law & Crime Network, Michigan Lawyer’s Weekly, NPR, WWJ News Radio and WXYZ. Mr. Hirzel is a dynamic speaker and frequently lectures on community association law throughout Michigan, as well as nationally at the CAI National Law Seminar, and is a two-time winner of the best manuscript award at the CAI National Law Seminar.

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