R&R Insurance Blog

Coinsurance is the percentage of property value that the policyholder is required to insure.

If one insures the property for less than that amount, the insurance company imposes a "coinsurance penalty" once a claim is filed.  The value is determined at the time of the loss. If the amount of insurance is found to be under the stated coinsurance percentage, then a penalty is applied reducing the claim payment.

Most business policies include a "coinsurance" clause, determining what percentage of its value the property must be insured for in order to be fully reimbursed for a loss.

Example: There is a building that one believes would cost $100,000 to replace and a coinsurance penalty in the policy of 80 percent. One insures the building for $80,000 thinking they have fulfilled the coinsurance clause. A fire loss causes $60,000 worth of damage so a claim is submitted. The insurance company subsequently determines that the replacement cost of the building is actually $150,000.

To determine how much to pay on the claim, the insurer divides the amount of insurance purchased ($80,000) by the amount that should have been purchased (80% of $150,000 or $120,000). The result (two-thirds, or $40,000) is the amount of the claim the insurer will pay.

If the building had been insured for at least $120,000, the insurer would have been reimbursed for the full amount of the loss.

Coinsurance can be tricky and could end up having a high cost if one under insures the property.

Reach out to one of R&R's Knowledge Brokers to ensure that you have the proper amount of coverage and to clarify any questions you may have on coinsurance.

While 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.