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Pam Rhode

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Understand the Fallout From a Coinsurance Penalty

Posted by Pam Rhode

Office-Building-Blog-ImageWhile it may seem complex, understanding the basics of a coinsurance penalty will save you from any surprises down the road. The first step in gaining an understanding starts with the Coinsurance Clause.

 

A Coinsurance Clause is a property insurance provision that penalizes the insured's loss recovery if the limit of insurance purchased by the insured is not at least equal to a specified percentage of the value of the insured property. The coinsurance provision specifies that the insured will recover no more than the following:

 

Insurance Carried

--------------------------- x Loss = Amount Recoverable

Insurance Required

 

As an example:

A building actually valued at $1,000,000 has an 80% coinsurance clause but is insured for only $750,000. Since its insured value is less than 80% of its actual value, when it suffers a loss, the insurance payout will be subject to the underreporting penalty. Assume it suffers a $200,000 loss:

$750,000 ÷ (0.80 × 1,000,000) × 200,000 = $187,500 Payout (less any deductible).

In this example, the underreporting penalty would be $12,500.

Business income coinsurance is solely a function of time; a 12-month period of time to be more specific. How long will it take, following a worst-case-scenario loss, to return the operation to pre-loss condition and capabilities? Knowing this allows the insured to accomplish two tasks:

1) Pick the correct coinsurance.

2) Ultimately decide on the limit of business income coverage to purchase (again, the amount subject to loss is a function of the coinsurance percentage and the percentage a function of time).

  • 100 percent = 12 months (12 months x 100%) Estimated Loss of Income (Amount Subject to Loss) Calculation: • Maximum Coinsurance Percentage x 12 months business income calculation = Amount Subject to Loss

As an example:

The policy states there is a $1M limit with 50% coinsurance. This means the 100% amount would be $2M. If, at the time of loss, the 100% amount was $3M, then the limit should be $1.5M (50% of $3M). Therefore the insured would be penalized 33% of their claim, and paid $1M versus $1.5M.

 

Contact your knowledge broker to learn more about how to avoid the potential fallout from a coinsurance penalty.

Topics: Business Insurance, coinsurance, coinsurance penalty