Author: Nancy Germond
Coinsurance may be the least mentioned yet easily explainable clause in both commercial and personal property and other policies.
You will find coinsurance clauses in many types of policies. These and other policies usually contain a coinsurance clause.
- Businessowners policy
- Commercial property policy
- Flood insurance policy
- Business income policy
- Dwelling policy
- Homeowners policy
- Health insurance
The coinsurance clause can hit your insureds where it hurts, in their wallet. It can also hit your errors and omissions coverage if your clients allege they did not understand the coinsurance language and any application that may reduce their loss payments after a claim.
What is Coinsurance?
Coinsurance is policy language that requires the insured to share in any property loss should the property not be insured to value.
Coinsurance requirements encourage insureds to insure their property to value through a discounted rate. If they fail to insure the property correctly, they become a co-insurer of their loss with their carrier if the limit of insurance they choose on their home or commercial building does not equal the specific percentage of their property's value – 70%, 80%, 90%, or even 100% -- at the time of the loss.
This is not the market value of the home or building, because that includes the land and other variables such as location. It is the cost to repair or replace the damaged property at the time of the loss.
The Reason for Coinsurance
The purpose of coinsurance is to have equity in ratings. If your insured meets the coinsurance requirement, the insured receives a rate discount. The coinsurance clause helps to ensure equity among all policyholders. In some instances, underwriters waive the coinsurance clause in return for stating an agreed value on the policy. However, with inflation, your clients should review that amount at least annually even with the addition of an inflation guard endorsement.
For an example of how the rate may apply, visit this article on coinsurance.
Few fire losses are total losses; most are partial losses. According to Insurance Services Office, about 85% of fire losses damage less than 20% of the property value. Only 5% of the fire losses damage over 50% of the value of the property.[i]
When underwriters rate property insurance, they base those rates on the ratio of expected losses to that property. Therefore, if insureds underinsure their property assuming they will not have a total loss, insurers may not generate enough premium to cover all expected losses.
Encouraging insureds to carry insurance to a specific value helps to avoid rate inequity among policyholders and ensure insurance carriers receive adequate rates.
In personal lines, adjusters will discuss “insurance to value" while in commercial lines, adjusters use the term “coinsurance."
Everyone Wants to Save Money
When it comes to insurance, we all try to save money. Your insureds may attempt to save money by undervaluing their home or business location, assuming they will never have a fire, much less a fire that is a total loss.
That's right, the adjuster will calculate the value of the damaged property at the time of the loss, not at the policy inception when your insured chooses a specific property coverage limit. This is critically important in today's era of high construction costs inflation.
Experts estimate construction costs hit a fifty-year high, up 17.5% from 2020 to 2021. That means many of your insureds may currently have inadequate property limits on their policies. If they do not, they will incur a coinsurance reduction after a loss.
Explain the Coinsurance Clause as Positive, Not Negative
The coinsurance clause is both a carrot and a stick. The carrot? It encourages your insureds to carry adequate levels of coverage by providing a premium reduction if they adhere to adequate coinsurance limits. The stick? Although the policy never uses this word (nor should you), it reduces the amount payable on the claim should a loss occur if the insured has failed to adhere to the coinsurance requirement. The coinsurance clause promotes rate equity among all policyholders in that class.
You will hear many agents, and some adjusters, refer to the reduction as a coinsurance “penalty." It is not a penalty. It is a policy provision or requirement. We advise you never describe it as a penalty.
Chantal Roberts, author of The Art of Adjusting: Writing Down the Unwritten Rules of Claims Handling, has this to say about the coinsurance provision.
“Fun fact: The insurance policy never says this is a 'penalty,' and we should not refer to it as such. It is a requirement of the policy to incentivize insureds to insure their property to the correct insurance-value so that they avoid becoming a co-insurer with the carrier," Roberts says.
“You've likely heard of numerous studies that humans are hardwired to memorialize bad news; so, when your client hears 'penalty' from you or the adjuster, she automatically thinks, 'Ah, I knew I wasn't going to be paid the full amount by the carrier!'"
The coinsurance credit for carrying insurance to value depends on the structure's fire resistance. A brick building would receive a greater rate reduction than a wood building, for example.
The Coinsurance Formula
The coinsurance formula is a simple mathematical formula.
Insurance Carried Divided by Insurance Required X Loss = Amount Recoverable
Mathematically, it looks like this.
Amount of Insurance Carried
Amount of Insurance Required X Amount of Loss = Amount Paid
Or, as we said old school, “Did Over Should X Loss."
The policy determines whether the deductible applies before or after the application of the coinsurance provision. If the policy is silent, the recommended best practice according to Adjusting Today is to apply the deductible first. This provides a slightly higher claim payout and gives the benefit of the doubt to your insured given the policy's ambiguity.
Claim Example Given a Coinsurance Reduction
Let's look at a loss given a policy with an 80% coinsurance clause.
Your insured owns a building valued at $800,000 at the time of loss with an 80% coinsurance clause. At the time of the loss, she carried only $600,000 of insurance. She then suffered a loss of $50,000.
Because she failed to carry adequate insurance, she'll incur a coinsurance reduction on the claim payout.
Let's look at the math.
$600,000 insurance carried
$800,000 insurance required = 75% X $50,000 - $1,000 = $49,000 = $36,750.
In this case, the adjuster applied the deductible before the coinsurance provision, so the $50,000 became $49,000 after application of that deductible. If the adjuster applied the deductible after the coinsurance calculation, the insured would receive $36,500.
The Coinsurance Visualizer
A agent long ago developed a coinsurance visualizer (at the bottom of that link's page) you can download to help explain the coinsurance provision and how it would apply after a hypothetical loss. Seeing visually how the coinsurance provision can impact your insured can help confirm they understand the policy provision's importance.
We cannot overstate the importance of insurance to value, especially with today's quickly escalating construction costs.
Words of Caution
Never rely on the amount the mortgage company requires for insurance. Their concern is their mortgage balance. In today's world where purchasers may put down 20% of the home's value at purchase to avoid mortgage insurance or because that property is a second home, the mortgage company's priority is that they do not lose their equity – the amount still owed on that mortgage.
The value the adjuster determines at the time of the loss is based on the covered property – for example, commercial property policies do not cover foundations, and the adjuster would need to remove that cost from the valuation.
Adjusters use valuation software tied to a specific zip code. The software developers update the software frequently. If your client must pay a large percentage due to underinsurance, ask the adjuster to see their valuation to ensure it only takes covered property into consideration, Roberts recommends.
During the pandemic, more than half of homeowners hired professionals for renovations. These renovations, including something as simple as an extended back deck, can increase the value of the home leading to a coinsurance issue.
It is wise to routinely contact your clients to see if they have undertaken any major renovations. The social media recommendations below can help you in social media or email campaigns and help to protect your agency liability.
Here are social media updates you can use to remind your clients to reach out to discuss their property coverage limits.
“Did you know your property policy no doubt contains a coinsurance clause? With property values and the costs to rebuild escalating, give us a call to discuss your coinsurance clause, which requires you to insure your property to a certain percentage of value."
“With escalating construction costs, the price to rebuild your home or office after a loss can create problems. Coinsurance is a property policy requirement that means you must insure your home or office to a specific value, often 80% of its replacement cost at the time of the loss. Contact us today so that we can review your current insurance and help you decide if you should increase your property limits."
“Most property policies contain coinsurance clauses. Different than a coinsurance clause in your health insurance policy, the property coinsurance clause states an insured value you must insure to that allows you to collect after a loss without any consequence for underinsurance."
[i] Fundamentals of Risk and Insurance, 11th Ed. Wiley, 2013
First published: August 19, 2022
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