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How To Lose $70,000 In 30 Seconds!

Coinsurance is an important part of each property insurance policy.  It may be stated in a percentage (usually either 80%, 90% or 100%) or it can be waived and not apply.

Most insurance buyers and many insurance personnel don’t understand coinsurance.  The issue is further confused by the fact that our health insurance policies (which we also don’t understand) uses the same term – “coinsurance” – to mean something completely different than its application to property insurance.

Under a medical policy, if you have coinsurance, the policy tells you how much of a bill that the insurance company will pay and how much you, as a patient, will pay.  For example, if one of your benefits has an 80/20 coinsurance and the bill is $1000, the insurer pays $800 and you pay $200.  Simple, right?

However, not so simple for property coinsurance.  Policy format might seem to indicate the same when you see the term “80% Coinsurance” on a property policy.  The terminology is where the similarity ceases.

The property coinsurance is like a warranty or condition of the policy.  The coinsurance states what percentage the insurance you are carrying bears to the value of the property you are insuring.  The value must be either Actual Cash Value (current market value) or Replacement Cost (cost to rebuild) depending on the policy you have selected.

At the time of a loss, the coinsurance clause comes out of the dusty regions of the policy to be activated. If the policy has  80% coinsurance, the insured must be carrying an insured amount that is NO LESS than 80% of the value of the property at the time of a loss.  If the amount carried is at least 80% or greater of the value of the property, the insured is paid 100% of his claim (not 80% as so many buyers think) and everyone is happy.

So what’s the issue?  Underinsurance is the issue.  Gotcha factor!!  If the amount of insurance that is actually being carried is less than the 80% shown above, the coinsurance clause fires up.  This is the way that insurance companies insure that they are getting a fair premium for the coverage offered, while allowing the policy holders to self appraise building values.

Here are some numbers as an example.  The current market value of your building is  $500,000.  By the 80% formula, you must buy $400,000 in property coverage.  Should you have a claim, the adjuster calculates the coinsurance to see if it is in compliance.  $500,000 X 80% = $400,000.  All is well and your policy pays 100% of your claim.

Let’s assume, though, that you become busy with business and life and fail to review the value of the building for five years. Every year, you tell your agent, “Renew as is – Nothing’s changed.” Because of increased costs of construction due higher labor and material costs, or because the market in your area has shifted, the building now has a valuation of $700,000.  After the loss, the adjuster again uses the coinsurance formula- $700,000 X 80% = $560,000.  Uh-Oh.  You should have been carrying (and paying premium on) $560,000 in policy coverage. 

Now the formula says you are paid your claim based on a percentage developed by dividing the AMOUNT OF INSURANCE YOU SHOULD BE CARRYING INTO THE AMOUNT OF INSURANCE YOU ARE CARRYING.  You have $400,000 of insurance and should be carrying a minimum of $560,000.  Now we divide $400,000 by $560,000 = 71.5%.  Assuming a damage repair bill of $250,000, your policy now pays out only $178,750 ($250,000 X 71.5%).  This is a $71,250 penalty.   Think about how much adequate insurance would have cost over five years.  Not this much. 

Something to watch:   Even if you have the building in compliance of the selected coinsurance provision, don’t insure the property for the compliant value (i.e. don’t insure a $500,000 building for $400,000) as you can create an almost immediate coinsurance penalty, especially in times when building costs and market values rise.  My suggestion is to always insure the property for 100% of value (either market value or replacement cost) with an 80% coinsurance clause. 

In property insurance language, “coinsurance” means that you are accepting a role as a co-insurer in the event of a loss and are willing to take less than the full claim amount.  Don’t let failure to pay attention cause you to unexpectedly pay, in the event of a property loss.