Recently, I had one of my clients call me up to go over his insurance policy. He had finally gotten around to clearing his desk and stumbled across of a renewal letter we sent that listed all of the ‘important’ parts of his policy – deductibles, limits, miscellaneous forms and such. When he got to the “Co-Insurance” portion of the property policy he stopped, picked up the phone and gave me a call…
“What the heck is co-insurance?”, he asked.
A coinsurance clause requires that the limit of coverage be a minimum percentage (usually 80%) of the insurable value of your property. If the amount of insurance carried is less than what is required by this clause, any claim payment may be reduced by the same percentage as the deficiency.
In other words, there is a mathematical formula that is implemented at the time of a partial loss that dictates how much the insurance carrier is going to write you a check for. As long as you are not outside of the predetermined percentage (i.e. 20%) then the recovery to you will be receive will not be reduced by penalty.
Amount of insurance carried ÷ Amount of insurance required × Amount of Loss = Amount paid by insurance company
Here’s an example:
Let’s assume Joe has a building that would cost $100,000 to replace if it were destroyed and his policy’s co-insurance clause is set at 80% (80% of $100,000 is $80,000.) . Let’s go further and say that to save on premium Joe reported to the insurance company that the value of his building was only $50,000.
Yesterday, an electrical fire broke out and caused $20,000 in damage to Joe’s building. Today, the adjuster showed up and determined that Joe under-insured his building and that his recovery check would be reduced proportionality to the amount that he was outside of his co-insurance agreement. The following is the formula that the adjuster showed to Joe to explain how –
$ 100,000 Building
$ 50,000 Amount of insurance Joe carried
$ 80,000 Amount of insurance Joe was required to carry (80% of $100,000 = $80,000)
$ 20,000 Amount of fire loss
$50,000 (carried) ÷ $80,000 (required to carry) x $20,000 (loss amount) = $12,500 paid by Joe’s insurance company
$ 7,500 Paid by Joe
Note that the above example does not take into account a deductible which would further reduce Joe’s insurance reimbursement. With this example, it’s easy to see why insuring your buildings to value is important. In this scenario, Joe thought he was saving money by under reporting the value of his property – in the end, Joe likely paid far more out of pocket than it would have taken to insure the building properly in the first place. Put another way, Joe became the “co-insurer” for his loss by failing to meet the insurance requirements of 80%.
Be aware of how improperly insuring (or under-insuring) your property can affect your insurance reimbursement. If you have questions about the proper amount needed, consult with a licensed and insured property appraiser. You may find that getting a insurance to value appraisal may actually save you money in the long run and the appraisal itself is more affordable than you think (a few hundred bucks) may save you thousands over the course of a few years.