Coinsurance clauses may be included in various types of insurance contracts, but are most commonly in commercial property insurance or inland marine insurance policies. Understanding what they are, the penalties that come with them, how to eliminate or minimize their impact with simple steps and how to calculate coinsurance penalties is vital to ensuring clarity and complete understanding of how your insurance policy works. Continue reading to learn more about coinsurance penalties below.
What is coinsurance?
First thing first, what is coinsurance? Coinsurance is a clause in an insurance contract that insurance companies use to encourage insured’s to ensure they are insurig their physical assets to an appropriate value. When an insurance company imposes co-insurance on a commerical property policy it should always be viewed as a potential penalty or negative. So how does it work? In exchange for the policyholder agreeing to carry a limit of insurance equal to a mutually agreeable replacement cost value insurers will agree to remove a co-insurance pentalty clause and write the policy on a stated amount basis. However, if an insured is not willing to or if the insurer doesn’t accept the replacement cost value as sufficient to meet a specific percentage of the property’s value (e.g. 80% or 90%) then the penalty is imposed. The easiest way to think about it is, if a policy aims to cover a property valued at $1,000,000 of replacement cost but there is a 90% coinsurance provision, the property must be insured for a minimum of $900,001 to avoid a coinsurance penalty at the time of the loss.
Coinsurance penalties
Coinsurance penalties come into play if the policyholder fails to insure the property up to the percentage specified in the coinsurance provision. If there is a claim, the policyholder effectivelyTa becomes a co-insurer, which means they would share in the loss. Coinsurance penalties are, therefore, dependent on the coinsurance percentage stipulated in the contract. While they are most commonly 80% or 90%, they could be lower or higher than this.
Coinsurance formulas
A coinsurance formula is a formula used to calculate the reimbursement that a policyholder is entitled to from a claim. This formula only comes into play when the policyholder (who is usually a property owner) does not maintain coverage at the specified value (e.g. if the policy includes an 80% coinsurance clause, but the policyholder only has coverage for 70% of the property and/or physical assets replacement cost value). Anyone who finds themselves in a situation where co-insurance is triggered and needs to file a claim will only receive partial reimbursement, which is determined by the formula which is summarized as did divided by should time the %. More fulsomely it’s exlpained…the coinsurance formula is simpler than you might think. You start by dividing the amount of existing coverage on the property by the amount that should have been carried according to the coinsurance clause. From there, multiply the sum by the coinsurance perfentage amount on the policy. The result is the amount of reimbursement that the policyholder is entitled to receive.
Calculating coinsurance penalty example
To help explain how to calculate a coinsurance penalty, follow along using the example below:
- Propertys actual replacement cost value = $1,000,000
- Coinsurance provision on property policy = 80%
- Required insurance coverage amount to avoid coinsurance = $800,000
- Actual amount property was insured for = $700,000
- Loss amount = $100,000
When the above claims scenario is calculated using the coinsurance penalty above it works out as follows:
The Actual insurance coverage amount is divided by the Required insurance coverage amount multiplied by the Loss amount. Using the amounts above, the calculation would look like this:
- 700,000 / 1,000,000 x 100,000 = 70,000
Therefore, using this example, the policyholder would receive $70,000 on a $100,000 claim. In contrast, if the policyholder maintained the required coverage amount of $800,001, they would not have been a “co-insurer” and instead would have received the full amount of the claim ($100,000) without penalty. As you can see coinsurance and commercial insurance is complex and complicated which is why it’s important to work with an insurance brokerage like ALIGNED Insurance that specializes in commercial/business insurance.
