How to Ensure Tenants Will Pay Your Entire Insurance Cost

Your shopping center leases probably require each tenant to pay its share of the center’s fire insurance, liability insurance, and other kinds of insurance. However, if you want to pass through your insurance costs to your tenants as a separate component of common area maintenance (CAM) costs solely by using a standard formula based on “gross leasable area,” it could leave you on the hook for costs you thought would be paid by your tenants. That’s because, if your leases base each tenant’s share of your insurance costs on a percentage of the center’s gross leasable area, but your anchor tenants carry their own insurance, you won’t get reimbursed in full for your insurance costs. You can protect yourself from this financial pitfall, though, by properly calculating each tenant’s share of your insurance costs so you aren’t stuck footing the bill for the shortfall.

Avoid Standard Formula

A common formula based on gross leasable area (GLA) to determine the tenant’s share of insurance costs looks like this: Owner’s insurance cost x (tenant’s area ÷ GLA).

Example: Your center has a GLA of 100,000 square feet. You pay $50,000 for insurance on the buildings in your center. Half of the GLA is occupied by a 50,000 square-foot anchor tenant supermarket. Occupying the remaining 50,000 square feet are a 20,000 square-foot drugstore and three small 10,000 square-foot stores. Under the standard formula, you would figure the annual contribution for each of the four nonanchor tenants in these five steps:

Step #1: Calculate the drugstore’s share: $50,000 insurance cost x (20,000 sq. ft. ÷ 100,000 sq. ft.) = $10,000;

Step #2: Calculate the smaller stores’ share: $50,000 insurance cost x (10,000 sq. ft. ÷ 100,000 sq. ft.) x 3 (number of 10,000 square-foot stores) = $15,000;

Step #3: Add the results of steps #1 and #2 together: The four nonanchor tenants would contribute $25,000 ($10,000 from the drugstore and $15,000 from the three smaller stores);

Step #4: Calculate the anchor tenant’s share: $50,000 insurance cost x (50,000 sq. ft. ÷ 100,000 sq. ft.) = $25,000; and

Step #5: Add the results of steps #3 and #4 together: The five tenants would contribute a total of $50,000 ($25,000 + $25,000), which covers your entire insurance cost.

But there’s a problem with those calculations: In reality, all five tenants may not contribute.

Tenants with Insurance Complicate Matters

Anchor tenants and tenants such as free-standing, fast-food restaurants usually have their own insurance policies. These policies cover all the properties at which the tenant operates. It’s more cost-effective for those tenants to include their portion of the center under their own coverage, rather than get coverage under your policy.

But look at what happens to the prior example if the anchor tenant provides its own insurance: The remaining four tenants’ contribution of $25,000 will cover only half of your insurance costs. You’ll have to make up the difference until you can get a new insurance policy. Even so, a new policy won’t make up for the shortfall in the other tenants’ contribution.

Example: Suppose you drop the anchor tenant from coverage and your insurance now costs $30,000. However, the tenants’ leases still say their shares are based on gross leasable area. The nonanchor tenants now pay the result of these steps:

Step #1: Calculate the drugstore’s share: $30,000 insurance cost x (20,000 sq. ft. ÷ 100,000 sq. ft.) = $6,000;

Step #2: Calculate the smaller stores’ share: $30,000 insurance cost x (10,000 sq. ft. ÷ 100,000 sq. ft.) x 3 (stores) = $9,000; and

Step #3: Add the results of steps #1 and #2 together: You will collect only $15,000 ($6,000 + $9,000)—enough to pay only half the insurance bill.

Split Your Insurance Premium

Splitting your insurance premium into two parts can protect your interests if you have at least one tenant with its own insurance. When you split your insurance premium into two parts, make sure that all new nonanchor tenants at the center are required to pay the center’s insurance premiums in two parts. Like our Model Lease Clause: Pass On All Insurance Costs to Tenants, yours should set up the split premium in your leases, first indicating that you’ll maintain certain types of insurance throughout the lease term, and that the tenant agrees to reimburse you for its pro rata share of the costs of your insurance relating to the center or its space as part of CAM costs [Clause, opening]. Next, discuss splitting the premium into two parts as follows:

First part. The first part of the premium should cover all of your insurance costs relating to the center, except those relating to common areas. Only the nonanchor tenants will pay this part. You will calculate their share by changing one number in the standard formula above—that is, instead of the “gross leasable area” component, you will use a “your insured area” component, which is the square footage covered by your insurance policy [Clause, par. a]. The formula for nonanchor tenants’ contribution would look like this: your insurance cost x (tenant’s area ÷ your insured area).

Example: Suppose you have a 100,000 square-foot shopping center, and the anchor tenant has its own insurance, so it drops out of the insurance pool. You pay $50,000 in insurance—$30,000 is allocated to the center’s costs, excluding the common areas. Only the four nonanchor tenants, with 50,000 square feet of total space, are responsible for this part of the premium:

Step #1: Calculate the drugstore’s share: $30,000 insurance cost x (20,000 sq. ft. ÷ 50,000 sq. ft) = $12,000;

Step #2: Calculate the smaller stores’ share: $30,000 insurance cost x (10,000 sq. ft. ÷ 50,000 sq. ft) x 3 (stores) = $18,000; and

Step #3: Add the results of Steps #1 and #2 together: You collect $30,000 ($12,000 + $18,000), which covers the entire first part of your premium.

As tenants enter or leave your insurance policy, this formula will automatically adjust each tenant’s contribution.

Second part. The second part of the premium should cover only the costs of insurance for the common areas. Both the anchor and nonanchor tenants will pay this part. You will calculate each of their shares by using the standard formula based on gross leasable area [Clause, par. b].

Example: Allocate the remaining $20,000 of your $50,000 premium as follows:

Step #1: Calculate the drugstore’s share: $20,000 insurance cost x (20,000 sq. ft. ÷ 100,000 sq. ft.) = $4,000;

Step #2: Calculate the smaller stores’ share: $20,000 insurance cost x (10,000 sq. ft. ÷ 100,000 sq. ft.) x 3 (number of 10,000 square-foot stores) = $6,000;

Step #3: Add the results of steps #1 and #2 together: The four nonanchor tenants would contribute $10,000 ($4,000 + $6,000);

Step #4: Calculate the anchor tenant’s share: $20,000 insurance cost x (50,000 sq. ft. ÷ 100,000 sq. ft.) = $10,000; and

Step #5: Add the results of steps #3 and #4 together: The five tenants would contribute a total of $20,000 ($10,000 + $10,000), which covers the entire second part of the premium.

Why does this part also apply to your anchor tenant? Even if an anchor tenant has its own insurance policy, it still must be responsible for paying costs relating to insurance for the common areas. After all, the anchor tenant will benefit from the common areas, but its insurance won’t cover them. For example, the anchor tenant should help pay for repair or maintenance work to the center’s parking lots, outdoor light poles, sidewalks, landscaping, and lobbies. Requiring the anchor tenant to contribute to this part of the premium helps reduce the cost to the nonanchor tenants and fairly allocates to everyone the insurance for the common areas.

Be aware that unless its lease says so, an anchor tenant may resist paying the second part of the premium. Therefore, include the following language in the anchor tenant’s lease, where it defines CAM costs. This way, the anchor tenant can’t argue that it isn’t required to pay that amount.

Model Lease Language

(x) The cost of insurance for the Common Areas.