Coinsurance: A Hidden Penalty of Your Insurance Policy

By: Dan Galos, CWCA, AFIS, SBCS, Sales Executive / Risk Advisory Solutions

A fire breaks out and burns part of the building where your business operates. You file a claim, and the adjuster comes out to assess the damage. A lot of time passes while you wait for a check, but when it finally arrives, the payment only covers a fraction of the cost done. 

“This isn’t fair! How can they do this to us?”

Well, did you read the contract you signed? When you purchase an insurance policy, you agree with the insurance carrier where they will pay for covered causes of loss as long as the loss meets the requirements of the many provisions within the policy. One of those provisions frequently overlooked is coinsurance.

You may be familiar with coinsurance from its use in the healthcare industry (i.e., you go to the doctor and have to pay 20% of the bill). Coinsurance in commercial policies doesn’t work the same way. In commercial insurance, the coinsurance clause states that you, the insured party, are insuring your property to the appropriate limit of coverage. The insurance carrier wants you to insure your property to full value. If a covered cause of loss occurs and your property is not covered to full value, you become the co-insurer of the risk and have to pay for a portion of the loss. 

What does this look like in real life? 

There will be a small amount of math here, so sharpen your #2 pencils and dust off your 6th-grade mathematics books. 

For the sake of simple math, say you purchased an insurance policy to cover a building you own with a limit of $600,000 and a $5,000 deductible. One day there is a small fire that causes $100,000 of damage. The insurance carrier looks and sees you have an 80% Coinsurance clause on your policy. Meaning, your building must be insured to at least 80% of its true value to have the full amount of the claim paid. The insurance adjuster finds that the true value of your building is currently $1,000,000, not $600,000, like you stated in your insurance application. Herein lies the problem. Your insurance policy stated that you must have at least 80% of the building’s value in coverage limits. 80% of $1,000,000 is $800,000, meaning you are short of having the proper coverage. 

The insurance carrier will now impose the coinsurance “penalty,” avoiding payment for the portion of the loss for which you did not properly insure the building. The formula looks like this:

((Coverage you have/Coverage you should have had) x Loss) – Deductible = Payment

To save you from digging out the old Texas Instruments calculator:

[(100,000 x (600,000/800,000)] – 5,000 = $70,000

In this scenario, because you did not insure the full value of the building, you ended up paying a portion of the loss. The insurance carrier only pays $70,000 of the loss, and you’re on the hook for the remaining $30,000. 

Coinsurance clauses can be at 80%, 90%, or 100%. The lower the coinsurance, the better; ideally, you will have it removed from the policy. Many times, it can be as simple as having your insurance broker request to have the policy written on an Agreed Value basis. This eliminates the coinsurance provision, removing the risk of having to pay for a part of the loss yourself as long as the building or property is insured to full value. Typically, this change can be made for little to no cost to you as the building owner. Many brokers overlook this point and leave their clients with a significant gap in coverage. 

Correctly insuring your building and property is pivotal to establishing a foundational risk management program. A relatively simple fix can protect your business from a significant amount of repair bills and headaches. Are you curious to know more? Call your Horton representative today to learn more about your policy provisions.