Understanding Coinsurance

Coinsurance is one of the most misunderstood concepts in modern insurance.  It is also an important concept because a coinsurance clause is found on most property policies.  The clause is only activated with a partial loss, but the impact can be significant.  If the coinsurance clause is activated at the time of loss, you will not be fully compensated for a partial loss.  Imagine your limit of insurance is $100,000 at the time you have a $10,000 fire but you can only collect $5000 because of the coinsurance clause.

Here is how coinsurance works:

·         In exchange for lower rates…

The industry has a number of actuarial reasons for adding a coinsurance clause to a policy, but there is also a benefit to the consumer.  With most policies, rates are less when the policy contains a coinsurance clause

·         You agree to be insured for at least 80% of the replacement cost at the time of loss

The only thing the coinsurance clause requires of a policyholder is that property be insured to value.  Contracts vary and some require 80% of the value, others require only 90-% or even 100% of value.  (Although we are using “replacement cost” in this discussion, if your property is insured on an “actual cash value” basis and your contract has an 80% coinsurance clause, you will be required to insure for 80% of the actual cash value)

·         If you do not keep your promise, you become a coinsurer and share in any partial loss

At the time of loss, the claims adjuster will determine if you have kept the coinsurance promise; he will simply compare the policy limit with an estimated value of the property.  If your limit of insurance is not adequate, you will only be compensated for a portion of your loss, and you will pay the balance.  You are a coinsurer

·         There is a formula in the policy that tells your share

The coinsurance clause of a property policy contains a formula that tells you what your share is.  The industry calls this formula Did Over Should.  It simply says that if you only did have half of what you should have had, the insurance company will pay for half of the $10,000 fire and you will pay the other half

The Bottom Line

The minimum amount of insurance you should carry on property is the limit that will satisfy the coinsurance clause.  If you are insured for that amount at the time of loss, the coinsurance clause will not be activated.  However, if you are only insured for 80% of the value of the property and you have a total loss, you will have a different problem.  You will have to decide which 80% of the property you are going to replace, because you will run out of limits.  Prudent policyholders simply insure for 100% of the value of their property