Property insurance policies, whether personal or commercial, typically have a coinsurance clause that makes the policyholder responsible for some of the risk being insured. Many coinsurance clauses state that the policyholder must be insured for at least 80% of the property value, but the percentage ranges from 70% to 100%.
How a Coinsurance Clause Works
A coinsurance clause kicks in when you file a commercial property insurance claim. Essentially, the clause penalizes you—the policyholder—for undervaluing your property by reducing how much money you recover after a loss. Your insurer still pays the claim, but the coinsurance clause will decrease the amount paid through a formula that considers:
- The amount of the loss
- The amount of coverage you were supposed to carry
- The amount of coverage you carried
Your insurer most likely won’t know that you’re underinsured until you file a claim. Once you file a claim, your insurer uses the formula, and the result is a reduction in your payout.
Tip: Meeting your coinsurance requirement doesn’t necessarily mean you are “fully insured.” A coinsurance clause may only require you to insure your property for 80% of its replacement value, which means a building valued at $100,000 can be insured for just $80,000. If a fire causes a total loss, the insurer still only pays the insured amount.
How the Coinsurance Formula Works
The coinsurance formula, also called the loss recovery formula, divides the actual insurance limit by the amount required by the coinsurance clause and multiplies it by the loss value. That sum minus any deductible is how much the insurance carrier pays on the claim.
The coinsurance formula looks like this:
What does that mean in practice? Let’s say you have business property worth $15,000, and you buy insurance with a $250 deductible and a coinsurance clause that requires you to insure it for at least 80% of its total value. This means you should get at least $12,000 of commercial property insurance, but you decide you want to save money on your premium by only getting $5,000 in property coverage. Unfortunately, you have a claim for $9,000. This is how the coinsurance penalty comes into play:
Because the loss recovery formula divides your property insurance limit by the required limit, falling short of the coinsurance requirement penalizes you in a claim. In the example shown here, the insurer only pays $3,500 on a $9,000 claim, leaving the policyholder short $5,500.
Even if your claim is a partial loss, your coinsurance clause kicks in and impacts the total amount your insurer pays. Every claim on the property can be penalized, and that creates more out-of-pocket costs.
Where to Find the Coinsurance Clause
The coinsurance clause often is found in the “Additional Conditions” section of a standard property insurance policy. It should also be listed on your declaration page, the one-page policy summary that comes with your copy of the policy.
Why Coinsurance Is Important to Understand
Business owners who insure property need to know about the coinsurance clause so that they can understand their coverage fully. Not only do they want to make sure they meet their coinsurance requirement, but they also want to remember to check with their agents when they buy additional property and to reassess their property insurance needs when it’s time to renew.
Business owners should also pay close attention to how their property is being valued and insured. While it isn’t common practice, less ethical agents may offer to insure property for a lower value to make pricing more competitive. By asking if you “meet the coinsurance clause requirement,” you protect your assets and avoid unnecessary out-of-pocket costs.
How a Coinsurance Clause Impacts Costs
Because a coinsurance clause creates a required minimum for coverage, it impacts your commercial property insurance costs. Policyholders who choose to insure their property for the minimum amount required pay a lower premium but end up covering more costs in a claim.
Additionally, a coinsurance clause in property insurance creates a situation where you may end up paying more for repairs than you expect. The loss recovery formula insurers use to figure out what they owe on a claim considers whether or not you’ve met the coinsurance clause requirements. If you haven’t, your insurer pays less on your claim, leaving you to cover any remaining costs.
Additional Coinsurance Definitions
We’ve focused this article on the coinsurance clause in a commercial property policy. However, you run into the term “coinsurance” with other types of insurance, including:
- Health insurance: Coinsurance in a health insurance policy refers to the percentage of medical expenses the policyholder pays after meeting the deductible. For example, a health insurance policy with 70/30 coinsurance means the insurer covers 70% of the bill leaving the policyholder responsible for the remaining 30%.
- Homeowners’ insurance: The property coverage in a home policy also has a coinsurance clause. The clause works the same way one does in a commercial property policy.
- Directors and officers (D&O) insurance: Although rare, some D&O insurance have coinsurance clauses, often because the state requires it. The coinsurance requirement may apply to defense costs or settlements and judgments, but some policies apply the requirement to both.
The coinsurance clause sets minimum limits to what a property can be insured for. Falling below these limits, normally 80% of the property value, means your insurer may reduce its payout on a claim. Insurance carriers do this to make sure they charge all policyholders a fair premium.