January 12, 2014

Should You Buy Tenant Default Insurance for Your Rentals?

A little while ago I heard about a product from AON called Rent Protect.    Its an interesting concept for insurance.  Basically you're insuring yourself against deadbeat tenants.   One the fears with being a landlord is that you'll run into a nightmare tenant who decides to stop paying rent then squats in your property as long as possible through the legal eviction proceeding.   If you add up the month or two they fail to pay the rent before evict and the eviction process it could add up to easily 2-4 months of lost rent.   The Rent Protect insurance product would pay you that lost rent.

If your rent is $0 to $1200 per month per unit then the cost of the insurance is $250 a year.    It goes up in cost marginally for higher rent values.  They say that "The plan will pay up to six months in lost rent, plus up to $1,000 for legal expenses associated with the eviction process."     And in the coverage details it list a deductible of one month's rent.   They also pay for tenants who die, are called for military duty or vacate a lease due to a hardship.

The idea is interesting and I actually like the concept.    Now I would not consider this kind of insurance at all if your rent is relatively low.  It makes more sense to pay $250 a year to insure a house with $1000 monthly rent than a small studio that goes for $400.     It seems a lot more reasonable for a property with a higher rent in the $1000 range given you could end up losing $5000 or $6000.   But is the risk higher real cost then that $250 premium?

Is the insurance 'worth it'?
To know if insurance is really worth buying you have to consider the potential loss and the risks of that loss.  I recently wrote about how often renters are evicted.  It was my finding that about 0.5% of tenants are evicted each year.      If your rent is $1000 a month then the policy would pay out a max of 6 months rent less 1 month deductible plus $1000 in legal expenses for a total of $6000 maximum payout.   You'd have to have 200 tenants to get one eviction on average.   For 200 tenants you'd be paying $50,000 a year in insurance.   This is pretty rough figuring but if my math is right here then people are paying about $50k in insurance for a likely payout of $6k.   Thats not a good deal.
SO we know that the premiums will cost more than the amount they pay out overall.    If you can handle losing rent for a couple months then you're be much better off on average saving the $250 and just handling the occasional lost rent.   And if you are running a rental then you really should have an emergency fund on hand to handle losses like what you get with a tenant who doesn't pay.  

On the other hand a new landlord with all their eggs in one basket might like the feeling of being protected against a high loss due to a tenant who won't pay and you have to evict.    But I think people have an exaggerated idea of how often tenants are actually evicted.       If you do a good job selecting tenants and handle late rent well then you should lower your individual risk of losing multiple months of rent to tenants.    The policy also has a 1 month deductible and quite often when tenants fail to pay they only get behind maybe a couple months more than not.    OK maybe you'll have to evict someone but its much more likely they'll leave after seeing the first 3 day notice or that they'll leave owing only 1-2 months of rent versus the maximum payout level for Rent Protect.  You're a lot more likely to get a $1000 check from Rent Protect than a $5000 check.  

One possible use of this kind of insurance is to take a gamble on a tenant with awful credit and charge them a little higher rent to cover the insurance.   If you raise the rent by $21 a month that would cover the $250/year cost.    The insurance just requires that the tenant not have bankruptcy, eviction or felony on the record.   But you could still rent to someone who has very low credit score.  But honestly you're better off trying to find a tenant who has decent credit and save yourself the headache that the risk of a poor credit applicant will give you.   

Bottom Line :   This is a nice idea but personally I think this kind of insurance is not really necessary and not worth the cost.

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