Coinsurance 101: Sharing the Risk

CalculatorYou’ve heard of coworkers, cosigning, and cofounders.  But have you ever heard of coinsurance?

The coinsurance clause is a provision which requires you to carry enough insurance on your property so the coverage amount is equal to a certain percentage of the property’s value (usually 80%, 90%, or 100%).  Why is this important?  Because if you don’t meet this percentage of value with your insurance coverage and then experience a loss, you essentially won’t have enough coverage to pay for your loss in full.

The purpose of coinsurance is to limit the liability the insurer has to pay, stemming from the fairness in premium charges.  While you may carry a lower coverage limit than necessary to save premium dollars, you then face the possibility that when you experience a total loss, you will not be reimbursed for the full replacement cost of the property.  However, most losses are partial losses, and the likelihood of a total loss is quite small.  You may be tempted to keep your insurance coverage limit lower than it should be, chancing that a total loss may never happen.  When you buy coverage for a lower limit, you pay fewer premium dollars than if the limit was the amount it should be. This means you’ll receive less coverage.  Essentially, premium paid is coverage earned.

Confusing, right?  Here’s an example. For example, let’s say you have a building insured for $100,000 and the coinsurance basis is 80%.  Let’s also say that the replacement cost value of the building is truly $150,000.  Based on the replacement cost value, and the 80% coinsurance percentage, you should insure the building for at least $120,000.  This amount would satisfy the coinsurance requirement.  But let’s say you purchased a limit of coverage that’s less than that figure and then experience a partial loss of $10,000 in damages.  Because you did not meet the coinsurance percentage, the amount of coverage you’ll receive for your loss is reduced in proportionately.  The formula is simply put:

DID divided by SHOULD times AMOUNT OF LOSS.

This means the amount of insurance that was purchased, divided by the amount that should have been purchased determines how much your insurer which actually pay. So for this example:

$100,000/$120,000 = 5/6 or 83% x $10,000 = $8,300.

The 83% is the factor that is applied to the amount of loss, which is $10,000.  This equates to $8,300.  Since the total damages were $10,000, the insurer will only pay $8,300, and you will have to pay for the remaining $1700 in damages out of your own pocket.   Had you purchased the $120,000 limit, the $10,000 claim would have been paid in full by your insurance carrier.

While saving a little premium now may seem like a great option, when you actually experience a loss, partial or total, you will end up paying much more out of your own pocket. Along with this, property valuations change in time due to various circumstances in the economy.  These include the cost of materials and labor to repair or replace the damaged property.   A building that cost $100,000 in labor and materials in the year 1950, would likely cost much more in the year 2013.

There is an alternative: the Agreed Amount Clause.  With this clause, your insurer agrees to waive the coinsurance requirement, so you are no longer required to keep a specified based on the coinsurance percentage.  The benefit of the Agreed Amount Clause is that there is never a chance you will have the amount of your loss reduced.  The amount of insurance provided is “agreed” upon by both the insurer and the insured.

Most companies still require the insured to have a certain percent of the property insured, to the best of their knowledge, but often times, a credit is provided.   Typically, a statement of property values signed by the insured is required to activate the clause. As an insured, it is best to discuss your property limits with your agent.  Your agent will contact the insurer if help is needed in determining the appropriate amount of insurance to purchase.

Do you have the coinsurance clause on your policy?  Have you ever experienced a loss where the coinsurance clause came into play?  I’d like to hear about your experience!

2 Comments on “Coinsurance 101: Sharing the Risk

  1. Pingback: Does Your Commercial Renewal Policy Need a Renewal Checkup?

  2. Pingback: Commercial Renewal - Steffey Insurance

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