A wave of mold-related insurance claims on commercial properties — which the American Risk Management Resources Network estimates at $6 billion in 2002 — has prompted insurance companies to carve mold coverage out of general liability policies. But instead of paying high premiums for mold insurance, some large apartment owners are choosing to self-insure. Smaller, private investors have taken an even bolder step by opting to “go naked” on mold coverage, preferring instead to plow the savings into preventive measures to make their properties mold-free.

Insurers who underwrite pollution legal liability policies have stepped up to the plate and are now selling mold coverage as part of environmental insurance policies. But this policy enhancement is pricey, involves high deductibles and provides limited coverage, according to Mary Jane O'Keefe, principal of San Diego-based MJ Associates, a risk-management firm specializing in commercial real estate.

According to the Environmental Risk Resources Association, the cost of adding mold coverage to a pollution legal liability policy is typically 7% to 10% of the amount of coverage purchased, and a 10% to 15% deductible applies. Based on this benchmark, a $1 million policy would cost an apartment owner between $70,000 and $100,000 annually, with a deductible ranging from $100,000 to $150,000.

Property owners must develop a mold-risk management protocol to even qualify for mold coverage, says David Dybdahl, senior consultant for the American Risk Management Resources Network. He notes that smaller owners are getting hit the hardest because the cost per unit decreases when spread over more properties.

Premiums vary according to how a property scores during the inspection process, notes Thomas Kosonen, an associate director at New York City-based Bears, Stearns & Co. Inc., a global financial and brokerage firm.

Condominium developers also are being priced out of the insurance market due to mold-related building defect problems, notes Jenny Jones, president of Elkins-Jones, a Los Angeles-based independent insurance brokerage firm specializing in commercial real estate. She says, for instance, that the minimum cost for liability insurance for developers in California is $50,000, which “can blow the budget and the project” for a small developer.

Owners Weigh the Risks

Post Properties Inc., an Atlanta-based real estate investment trust (REIT), is among the large apartment owners opting to self-insure. Meanwhile, StarPoint Properties CEO Paul Daneshrad, whose Los Angeles-based firm owns 3,000 apartment units, opted for no coverage whatsoever. To his way of thinking, it's more more prudent to invest in ensuring his properties are mold free.

In considering the risk of foregoing coverage, Daneshrad says that cost was indeed a factor. But unlike earthquakes, he says, “Mold is something within our control, so we chose to take an aggressive posture to prevent mold and manage the risks. Having insurance doesn't stop you from being sued, and it only provides partial coverage for economic loss.”

Property owners need to analyze the individual profile of their properties — such as the age and past history of plumbing problems — before making the decision whether to insure, Daneshrad notes. “With all that said, we decided that we were better off managing this risk ourselves.

“I think the message here is if you don't feel comfortable managing the risk yourself — then insure,” continues Daneshrad. “Then ask yourself the question: Do I have sufficient infrastructure and resources to really control the problem through not just maintenance, but management and administration?”

All owners interviewed by NREI for this story are implementing aggressive prevention and management policies to limit their liability risk. Such policies include conducting semi-annual mold inspections and ensuring immediate repairs, adding addendums to leases that define a tenant's responsibility to report leaks and mold occurrences, and documenting all preventive maintenance and repairs.

Managers for Daneshrad's 3,000 apartment units, for example, seize every opportunity to query tenants about the presence of mold. When tenants request maintenance services of any type, they must complete and sign a form that asks if they have had any water leaks or evidence of mold in their units, he says. “That way they can't come back after two years and claim a health problem from mold,” he explains. “Although this hasn't been tested under mold litigation, we think it would hold up.”

Private investor Zaya Younan, CEO of Los Angeles-based Younan Properties, which owns 480 apartment units in addition to 3 million sq. ft. of office space and hotels, believes it makes more business sense to eliminate mold than pay to insure against it.

Younan, who is trained as an engineer, notes, “Mold is everywhere. It's a fungus that develops with trapped humidity. If a window breaks, you have penetration of moisture. I can't prevent the mold from happening, but the question is how you react,” he says, noting that it has to be quick because air quality can be affected within eight to 12 hours. “It's just as treatable as termites. Once you determine the severity, there are various ways to treat it.”

Some developer-owners also are spending a little extra cash on the front end of the development process to install mold prevention systems that may save them money later.

BRE Properties, a San Francisco-based apartment REIT, invests time and money upfront to prevent mold problems down the road. Although BRE Properties does carry mold liability insurance, Peter Rocereto, the firm's national vice president for construction, says BRE is developing strategies to address moisture build-up that occurs under specific climate conditions.

In communities located along the Southern California coast, for example, the company installs dehumidifiers in the HVAC systems to remove moisture indoors, as well as exhaust fans in areas prone to stagnant air such as walk-in closets. It costs $600 to $700 per unit to add the system to new construction projects and $2,200 to $3,500 to retrofit existing buildings, explains Rocereto.

Abbie Cohen, an environmental attorney at the Philadelphia-based law firm of Dechert LLP, says the mold problem raises the need for building owners to establish environmental policies.

For example, owners should consider the role of air-conditioning systems in preventing moisture build-up when shutting a property down for renovations, she notes, adding that the systems are set to automatically turn on or off according to the number of people in a building. “If there is no one there, the system shuts off and too much moisture gets into the air,” warns Cohen.

Why Mold Won't Go Away

The hysteria over mold litigation began in 2000, caused by several high-profile cases, intense media coverage and uncertain science. The toxic-mold issue revolves around three mold or fungus species that that contain mycotoxins, which are thought to be dangerous when released into the air, according to Linda Striefsky, an attorney with the Cleveland-based law firm of Thompson Hine LLP.

This includes stachybotrys chartarum, a greenish-black fungus that is often the focus of mold litigation cases, as well as penicillium and aspergillus, which may aggravate medical conditions such as asthma.

Media coverage may have fanned the fires of litigation, but Striefsky contends a lack of federal regulatory standards that address mold as a health hazard is the main reason for the acceleration in mold claims. Mold is a naturally occurring organism that is found indoors and outside and has not been recognized by the scientific community as a hazardous substance like asbestos or lead, she says.

“While there is little disagreement that certain types of mold can aggravate specific existing conditions, such as asthma, can mold found in homes or commercial buildings make people sick? That is, quite literally, the million-dollar question,” Striefsky says.

Lacking standards that address “safe” levels of mold, proper identification of mold and methods of mold remediation, states are beginning to address the problem on their own. California was the first state to do so, enacting the Toxic Mold Protection Act of 2001. This law provides guidelines for mold remediation, public education materials and disclosure requirements, notes Malcolm Weiss, an attorney with the Los Angeles-based law firm of Jeffer, Mangels, Butler & Marmaro LLP.

“Potentially, this law could lead to the creation of a thorough regulatory structure for mold and other indoor air problems,” he says.

Lawyers Pursue Deep Pockets

Striefsky warns that with environmental insurers now placing a cap on mold coverage, attorneys are finding it more productive to take on a mold case as a class-action suit because the “pocket is deeper.” Case in point: A class-action lawsuit was brought against Archstone-Smith, a Denver-based apartment REIT, by tenants at the firm's Harbor House South high-rise apartment property in Bal Harbour, Fla. The firm settled the case earlier this year for $25 million. A spokesperson for Archstone-Smith verified the settlement amount, but declined to comment on the specifics of the case.

Hilton Hotel Corp. also filed a $56 million suit against 18 companies and individuals for construction defects in its $95 million Hilton Hawaiian Village Kalia Tower. The hotel was forced to close one year after opening due to mold infestation.

Corporate risk managers also are watching federal suits filed last year against IBM by employees at the firm's North Carolina research campus and Denver International Airport by United Airlines employees for mold-related health issues.

Product Solutions

Water intrusion resulting in mold is the major reason liability insurance for developers has skyrocketed, according to Stan Luhr, president of Quality Built, a San Diego County-based firm that provides quality assurance services to developers.

He contends that a focus on production capacity rather than quality control is responsible for the majority of mold-related building defects. But stringent energy standards have exacerbated the problem because they require tightly sealed commercial buildings, which lead to a greater potential for poor air circulation and mold-related air quality problems, Luhr says.

But mold risks can be reduced in new construction and renovation projects by eliminating the food source, according to Charles Perry, a member of a Mortgage Bankers Association task force charged with developing mold-prevention protocols.

He is pushing for an industry-wide standard that would require builders to use mold-resistant materials, such as a new inorganic gypsum wallboard that is faced with fiberglass rather than the paper used on standard drywall. Cellulose, which is mold's primary food source, is used to adhere the paper to the gypsum filler.

“The cost to remediate mold in one condo, apartment or nursing home room is $25,000 to $30,000,” says Perry, adding that 70% to 80% of a building's surface area is drywall. “To change to mold-resistant material costs about one-half of 1% of the total construction cost, or about $400 to $500 per unit.”

The Role of Standards

The key issue for lenders is limiting the risks for mold exposure. The American Society for Testing Materials International (ASTM), an organization that develops technical standards for materials, products, systems and services, is working on a set of standards to identify mold and the deficiencies it causes. “If ASTM develops standards to live up to, it would make our job easier,” says Kosonen of Bear, Stearns & Co.

Those standards, however, are one to two years away, according to Tim Brooks, ASTM director for technical committee operations. He notes that ASTM is working on mold-resistant materials standards for paint and coated products and uncoated products like drywall, as well as a guide for conducting a mold screen to assist property inspectors.

In the meantime, lenders are treating mold like any other environmental issue, applying “best practices,” according to Clay Sublet, CMBS director for KeyBank Real Estate Capital's commercial mortgage group in Kansas City. “We deal with these problems on a case-by-case basis,” he says. “There's no policy on mold, and so far we haven't seen the need for one.”

Similarly, Kevin Kleen, senior vice president and chief underwriter for ARCS Commercial Mortgage, a national multifamily lender based in Calabasas Hills, Calif., says his firm only requires mold liability coverage when there is a known risk. If the risk is high, the borrower is required to pay 100% of the premium upfront for the life of the loan. “Some go elsewhere when they see the cost of this,” he says.

Daneshrad, the Los Angeles-based apartment owner, believes that mold problems are a reflection of poor business practices. He emphasizes that a well-maintained property is not only critical to limiting risks, but also is good for business.

“Well-run, well-maintained buildings have less turnover, less liability and less risk. It helps with tenant retention,” he notes. “Every time a unit turns over, it costs the owner anywhere from $200 to $700. So keeping tenants happy is a win-win.”

Patricia L. Kirk is a Dallas-Fort Worth-based writer.