Coinsurance: What It Is & Why You Don’t Want It

A coinsurance clause typically appears in the “Conditions” section of an insurance policy. If you’re short on time, here’s the bottom line: you don’t want it.

Coinsurance can take many forms in the insurance world. The general concept is that coinsurance shares risk. For commercial property, a coinsurance clause requires the building owner to maintain a specific percentage of the building replacement cost. Failure to meet this minimum coverage requirement will incur penalties in a partial loss.

Confused? Here are a couple of examples.

Coinsurance Scenario: Partial Loss

Let’s say that John and Jane Smith purchased a Brooklyn brownstone in 2008. They insured the property for $2 million, the replacement value at time of purchase. Their policy had an 80% coinsurance requirement and a $5,000 deductible.

Each year when they renewed the insurance policy, they kept the same $2 million limit.

Fast-forward to 2016. The Smiths’ brownstone now has a replacement value of $3.1 million. An electrical fire causes $500,000 in damage.

• Based on an 80% coinsurance requirement, the Smiths should have $2.48 million in insurance coverage (.80 x $3,100,000).
• Their $2 million limit is 80.6% of the coinsurance requirement: $2,000,000 / $2,480,000 = 80.6%.
• For the $500,000 loss, the insurance carrier would penalize the Smiths $97,000 ($500,000 x .806).
• The $5,000 deductible would come out of the gross insurance recovery of $403,000.
• The Smiths would net a $398,000 recovery in this partial loss scenario.

Rather than purchasing a policy with a coinsurance clause, building owners should look for insurance with an Agreed Amount Endorsement. The insurance carrier agrees that the amount of coverage carried will be sufficient to avoid additional penalties in partial losses. However, this endorsement does not guarantee that the purchased coverage will cover the loss.

Coinsurance Scenario: Total Loss

Continuing with the above example, let’s suppose that the fire resulted in a total loss. The Smiths would only receive $1,995,000 ($2 million limit, less the $5,000 deductible). In this case, the unfortunate family would be penalized the difference between the coverage limit and the actual replacement cost of the property.

Even if the Smiths had a policy with an Agreed Amount Endorsement, they would still only recover a fraction of their property’s replacement cost.

To avoid these unpleasant situations, we recommend reviewing your commercial property insurance with your broker at least on an annual basis.

Want to test out your own scenario? Use the calculator below.