Should You Allow Damage Insurance in Place of a Security Deposit?

security deposit

I own a vacation condo on Lake Erie, just outside the town of Geneva-on-the-Lake, Ohio. Like half of the people who own apartments in the building, we rent out the property on a short-term basis when we are not using it.

If you rent property to someone else, you face the possibility that the person renting will damage it. That means that I, like the many people around the world who now rent properties online through sites like Vacation Rental by Owner (VRBO), Owner Direct and Flip Key, face an important decision about how to protect themselves from losses from renter-caused property damage: require a security deposit or ask renters to purchase damage insurance?

Damage Insurance Versus Security Deposit

The field of economics has a very clear answer to this question. When you rent property to someone else, there is asymmetric information. Because the owner does not know how well the renter will treat the property, charging a security deposit is a good idea. Renters will have an incentive to take care of the property to recoup their security deposit. If you are renting a condo for the weekend and you have paid a $500 refundable security deposit, you’ll think twice about having a wild party or leaving your kids unsupervised – one broken table could double the cost of your stay.

However, many of the vacation rental websites offer damage insurance as an alternative to a security deposit. For a $49 fee, Homeaway, for example, offers $5,000 worth of damage protection to short term renters of vacation properties.

In my condo building, several of the owners allow renters to purchase damage insurance instead of paying a security deposit. Their reasoning is that the insurance provides more damage protection. If a renter causes $4,500 worth of damage to their condo, they may be able to recoup all of their loss from the insurance company, but if they take a $500 security deposit, they know they can only recoup up to $500 worth of damage from yhose funds. Moreover, because the decision to return the security deposit resides with the homeowner, some potential renters balk at putting up $500 against damage for a stay of similar cost.

As an economist, I am surprised by my neighbors’ approach. With insurance, the owner is giving up the right to decide the validity of damage claims. If you’ve collected a security deposit and someone breaks a television, you can just deduct the cost from the security deposit, which is already in your possession. If you go the route of insurance, however, you run the risk that the insurance company will decide that the renter wasn’t responsible for the damage and won’t pay the claim.

More importantly, the choice of a security deposit or insurance demonstrates a classic moral hazard problem. Moral hazard is the idea that people will take more risks if they don’t bear the costs of their actions. For example, if you have a security deposit you want back, you will be more likely to tell your kids not to use the table in the living room as a piece of gymnastics equipment than if you have paid for insurance that covers damage resulting from their gymnastics show.

Over the years of writing for Small Business Trends, I have learned that many people who read my posts know a lot about the topics I discuss. Therefore, I am sure there are many readers who have a lot of experience with the damage insurance question.

So tell me and the other readers of this column: If you were renting out a vacation condo, would you insist on a security deposit or would you allow renters to purchase damage insurance instead?

Jumping Photo via Shutterstock


Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

20 Reactions
  1. Insurance sounds better in theory. Of course, it’s all in the fine print, don’t you agree? Will an agent inspect the property before a renter stays there each time? Seems to be the only way it would work – in theory.

  2. I prefer a damage deposit for my rental, though the industry seems to be trending towards insurance.

    Another factor to consider in the decision is that withholding a damage deposit can often result in a combative response by a renter, which could include a negative review, which could have a far greater cost to you over time.

    Depending on how many existing (positive) reviews you have, a negative review could be far more expensive. You may be faced with the decision of whether or not to withhold a $500 damage deposit to fix that TV, when doing so might also cost you tens of thousands in lost rental revenue due to a bad review.

    I still prefer a damage deposit due to the misalignment of interests that insurance brings, but I just don’t think withholding the damage deposit is always that easy, and that needs to be factored into the decision, as well.

    • We also have a short term rental that we started managing about 2 years ago. In the beginning, we thought the insurance route was the better way to go until we had to file a claim. Our condo had brand new everything and a guest came into our condo and actually peeled paint off the walls, tore closet doors off the tracks, they drew their initials into my dining room table which had a glass top covering it and they left the condo filthy dirty. We had pictures proving this guest had done all the damage plus receipts for all the work we had done prior to renting out our condo. We could only collect for the paint not the painter and the supplies the furniture guys used to fix our table but not his time and the replacement costs of the door but not the labor to hang the door. Oh and the extra cleaning that had to take place because how filthy this guest left my condo was on us as well because that was normal wear and tear. The next year we started collecting a damage deposit and we have not had to keep one deposit. Insurance protection is another entity with their hand in your profits.

      • We have had guests damage things and then our CSA insurance through VRBO/Homeaway paid for installation costs or repairs. Our biggest expense is replacing quiet-close toilet seats. Either we rent to obese people or people with unruly children, but I simply cannot keep absorbing costs to replace toilet seats. I submitted the receipt for a new toilet seat each time along with my handyman fee of $17 to install.

  3. From the business perspective (renting out the property) the best idea might be to follow the market. In other words, accept either a security deposit or evidence of Property Damage Protection, as the customer prefers. While some renters may balk at putting up $500, they should accept the requirement for a low cost Property Damage Protection product and may indeed welcome the protection it affords them. Meanwhile, many renters would entirely expect to pay a security deposit and balk at the idea of being ‘forced’ to purchase an insurance product at added vacation expense. The Landlord’s decision here might also consider the demand for the particular rental property in question.

  4. Security deposits are limiting. But then you’ll always have the money in case the renter said that they want to leave your house. We use it to cover the blank months. An insurance, on the other hand, will not be able to make us do that. While it can cover the damages, we will not be able to use the money for other purposes.

  5. This is an interesting article with issues to consider. I just bought a condo, to be ready by 2018, with plans to rent out for rental income, instead of earning lower interests from fixed deposits.

    • I have a hazy recollection that deposits of any kind are not supposed to be commingled or touched, but kept in trustee accounts until, in the case of damage deposits, damage occurs. It’s the same as an escrow account. Check with your lawyer.

  6. I am a owner of a vacation rental and have used damage insurance for years. It always seemed so much more convenient. That is until a guest damaged my property. She told the insurance company that she didn’t do it, and the claim was denied. So basically the insurance is protection only with honest guest who you have good rapport with. But those aren’t the ones who damage your property

    • Louise Batstone

      I found that if you email the guest about the damage prior to filing the claim, let them know that there is no deductible and no cost to them as they already paid for the policy, but the insurance company will call them to ask about the claim, then they are fine admitting it. I remind them that any claim not covered by the insurance is down to them to pay as per the rental agreement. This usually ensures a smooth claims process.

  7. I’m a frequent guest on Homeaway, VRBO and Airbnb. As a guest, I would always much rather the insurance. For whatever reason, the first two offer insurance, but Airbnb does not. It’s kind of annoying and might lead to me not using them anymore. I need protection as a guest. Accidents happen.

  8. The property damage protection insurance is a huge con. I’ve just paid $69 for 3 nights – that’s $8395/year. I don’t believe the owner is paying that much insurance. It’s just another way to rip you off. My rental went from $487 to $859 after all the bogus charges had been added on.

  9. I own a vacation rental and I give my guest an option. They can purchase PDP insurance and pay a $100.00 refundable security deposit or pay a refundable security deposit of $500.00. This has worked extremely well so far I I actually had to file a claim on a matching set of chairs of which one was damaged beyond repair. I simply submitted a dated picture of chairs pre damage and damaged chairs and the receipt. The company reimbursed me a pro rated amount for a set of chairs. I was satisfied and guest was happy they did not have to pay for the chairs. I do not throw away bills for items purchased for my rental.
    Also, by collecting the refundable security deposit, I can return the deposit with a thank you note.

  10. I own a historic property located near ski resorts and snowmobile trails and summer mountain hiking and outdoor activities. I have a rustic barn that I allow weddings and events to take place in. Most of my wedding couples come to me because they cannot afford the huge costs of weddings when they are paying themselves. Because I require property damage protection by way of a $99 insurance policy, I get far more bookings and revenue as a result. The influx of business and revenue is because of they way I’ve set up my rentals. I’ve filed 2 insurance claims (a cracked toilet and historic lamp damage) and both were paid in full. The price of my rental is high in comparison to my surrounding area because my property is considered luxury but divided amongst the quantity of guests it is very reasonable. This property damage protection policy protects my investment without having to charge an outrageous amount for deposits that deter bookings.

  11. Similar to John’s story from March 10, 2015, I am a owner of a VRBO rental and offered the damage insurance to renters through the website. A guest damaged my property (carpets, mattresses, couch, wood tables). I submitted a claim with pictures and receipts. I stopped after $5,000, the maximum coverage, although there was much more damage than that. The renter told the insurance company that he didn’t do it. Claim denied. The insurance policy is owned by the renter.

  12. Similar to John & Malia’s story, I am an owner of a VRBO rental in Naples Florida. I Require a $500 deposit for damages and also require the purchase of an insurance policy for accidental damages. The insurance company has total control of the claims they pay claims based on the GUESTS statements/comments. I had guests that left damages beyond the $5,000 policy and filth beyond belief. I sent the guest a list of the damages and asked how they occurred (broken lamps, damaged tables, broken vertical blinds, broken faucets kitchen & shower, broken floor tile, damaged pool table, gum in dryer and all carpets, etc…) . He claimed the list was totally fabricated. I submitted the list of damages with pictures and receipts to the insurance company and they refused payment claiming the guest would not cooperate with them. Very frustrated home owner especially since VRBO allowed him to submit a 1 star review when I had 25 5 star reviews in less than 1 year.

    • I also have had delayed or no reimbursement from insurance for damages not promptly reported either by the renters who did it, housekeeping, or the subsequent renters. I now have them take out the. Insurance and a refundable deposit; in a 5 hour turnaround time I also need to have money for repairs if possible, not wait months for insurance to make a decision.
      Finally, the issue of who decides what is valid. If your renters cause intangible damage such as noise keeping up neighboring renters or residents, you have a way to compensate that I doubt insurance would cover.
      As to reviews, if you receive a retaliatory review there is a chance it may be removed from the website; at the very least you can answer it.

  13. I actually do both a $200 ($300 with pet) deposit and $1500 of pdp (costs renter $59) unless it’s a repeat renter. rarely does a guest ask why both but my explanation is simple. If I spend extra time to clean above what I consider to be acceptable, I will take that from a security/damage deposit. I don’t want to hassle an insurance company over $50 and have to prove what is “excessive”. plus it comes into play when there’s a cancellation. if it’s outside of 60 days, it’s forfeited.
    PDP would cover damages.

  14. I own a home in Florida, and use vrbo. I charge a 500.00 refundable security deposit, and require the guest to pay for a 5000.00 (99.00) damage protection policy. I have had a few questions on this, but no negative reactions. Each has its own benefits, but together it gives the homeowner a better option should damage occurr. The security deposit also covers excessive cleaning charges, as well as misuse of utilites, such as a guest running up the electric, water or ordering PPV. I am concerned to hear that the insurance companies are so spotty on the claims as I have never had to file one yet.

  15. A few years back, in Ocean City NJ, ALL the realtor rental agencies switched from security deposit to insurance for vacation rentals As owners, we had no choice, and could not opt out. Of course those agencies saw it as less burden on the renters, and with the $5k max claim, more peace of mind for the owners. As an owner, I disagreed, and for a number of reasons already presented here. First, there is an inherent “human reward” in a refundable security deposit. If you leave the property in the same condition you found it, your reward is your security funds back. With the insurance, since the renter isn’t even responsible for a deductible, they could just leave with all your electronics, or put their foot through your 80 inch big screen, shatter windows, or do whatever they please because “they’re covered”. I could see a “so you forced me to buy this, so i’m Getting my moneys worth”. In a time of ever increasing entitlement attitudes, that worries me for sure. Second, the rental agencies just lifted a burden off of them in the form of escrow and refund management, while, more than likely, getting a $5 or $10 kickback on every policy they force upon the renter. Lastly, as a weekly rental owner without property managers, it is my burden to drive to my unit and clean between rentals. I have a 4-5 hour window to ensure the property is in the like new condition I expect for each renter. The insurance company will require me to file a claim, and wait for decisions and payment. Meanwhile, I have to run around locating and repairing items within the tight window. And the closest Home store to me is 20 miles away, along with the traffic leaving and arriving for the next rentals. I would still place my value on the human reward aspect vs the “security of a policy” if I had the choice.