Whether you need property insurance for a building that you recently purchased or you’re shopping around for new insurance, you may encounter a variety of terms that leave you somewhat puzzled. One of those terms is coinsurance.
It’s not unusual for policyholders to face a penalty if they fail to purchase a sufficient amount of insurance. That penalty is referred to as coinsurance. You might rightfully wonder why an insurance carrier would care about the amount of insurance that you purchase. The reason is related to the ratio of insurance to value, or the limit of insurance to the value of the subject property.
Why is Coinsurance Necessary?
Basically, the purpose of coinsurance is to provide assurance that the insurance carrier will receive a sufficient premium for the level of risk insured. Otherwise, there’s a risk that you might purchase an amount of coverage less than the actual value of the covered property. Coinsurance can kick in regardless of whether your property is insured for the actual cash value or its replacement cost. The penalty, however, doesn’t kick in if you purchase a sufficient amount of insurance. It’s also important to note that the inclusion of a coinsurance clause in your policy won’t have any effect on you unless you experience a property loss. You’ll usually find coinsurance clauses in the “Conditions” section of the policy. It’s also important to note that just because there is a coinsurance clause in your policy doesn’t mean that you’ll be subject to coinsurance. The clause only applies if the policy contains a coinsurance percentage in the “Declarations” section of the policy.
If that should happen, the insurance carrier will then compare the amount of the insurance limit listed on your policy to the amount of insurance you were required to purchase based on the coinsurance clause. In cases where the ratio is less than one, you’ll likely be subjected to a coinsurance penalty.
Coinsurance in Real-Life Situations
Let’s take a look at an example. Let’s say you have a building with a replacement value of $1 million and your policy contains an 80% coinsurance clause. This means that your building must be insured for a minimum of $800,000 in order to avoid a coinsurance penalty. Suppose you tried to save money by insuring the building for only $600,000. The building sustains damage that will cost $100,000 to repair and you have a $5,000 deductible. Based on the 80% coinsurance requirement, you should have purchased $800,000 in insurance. The ratio for the amount of insurance you carried divided by the amount actually required is 0.75 ($600,000/$800,000). Your loss was $100,000, but your insurance company will only pay ($100,000 x 0.75) minus the $5,000 deductible, which is $70,000, which means you are subjected to a $30,000 coinsurance penalty.
Are you interested in learning more about how you can avoid coinsurance? Evergreen Insurance can help you to determine your commercial insurance requirements. Contact one of our representatives today.