Coinsurance, What You Don’t Know Might Cost You

By Todd Olivieri

Coinsurance, What You Don’t Know Might Cost You

Is your property undervalued?  It’s a simple question with serious implications thanks to an ugly clause embedded in most commercial and residential policies that could cost you money and hamper your ability to recover from a loss. The clause is called coinsurance and in this brief blog, we’ll take a look at how these clauses work, why their invoked and how to avoid getting burned by them.

Simply put, coinsurance is a provision in a commercial or residential property policy that requires the policyholder to share in a claim’s cost, AFTER meeting your deductible. How much the policy holder pays (again, beyond the policy’s deductible) is determined by a formula defined in the policy, as is the trigger for its being invoked.

The Coinsurance Formula:

Coinsurance can be applied in various ways.  The required amounts of coinsurance are at least 80, 90 or 100% of the properties’ replacement value.  Drop below that 80 percent of replacement value level and the coinsurance clause kicks in and any claim filed will only be partially reimbursement based on the formula laid out in the policy.  Typically, property insurance policies are issued with a coinsurance penalty to make sure the property is insured close to replacement cost.

The coinsurance formula in the property owner’s policy sets the reimbursement amount that the policyholder will receive from a claim.  The formula becomes effective (i.e., is invoked) when the policyholder fails to maintain coverage levels within the policy.

Here’s how that works.

Keeping the numbers round and manageable for this example, let’s assume that your property is valued at $100,000 but insured only for $40,000, and a loss estimated at $40,000 occurs. If your policy has NO coinsurance clause, you’d receive $40,000 from the insurance company. Under that same scenario, however, a policy with a coinsurance provision calculating against the standard 80 percent clause, you’d receive only $20,000 on the claim.

In this example, because you carried only HALF ($40,000) of the 80% ($80,000) insurance required by the coinsurance clause, you’d receive only ONE-HALF ($20,000) of the $40,000 loss. That’s not good, but it’s actually even worse because your policy’s deductible on the loss would still apply, meaning that amount would also be deducted from your claim payout.

So clearly you want to avoid invoking a coinsurance clause. The best defense to avoid costly penalties during a loss, of course, is to have the coinsurance waived or an agreed amount added to the policy. Barring that, the other way is to take a close look at your policy’s limits and ensure they are high enough to protect your property against a possible loss and you from the dreaded coinsurance clause.

To get those limits right, don’t guess or do a casual comparison of similar property values - have a licensed appraiser perform a cost approach appraisal. This type of appraisal is essentially a detailed breakdown of what it would cost to rebuild the insured asset TODAY if it were destroyed – from materials to labor. It’s also important in this appraisal to take into account the value of the land (and deduct for any depreciation).

When it comes to your insurance, it doesn’t pay to cut corners. If you need a deeper dive on a cost approach appraisal, help navigating the coinsurance maze or any other risk management challenges connect with a Risk Strategies Real Estate Practice expert today.