What’s a Coinsurance?
Coinsurance is a clause in most commercial property insurance policies. In a replacement cost policy, it is designed to encourage policyholders to carry an adequate amount of insurance to cover the entire loss amount, except for the deductible. The encouragement comes in the form of a penalty, called the coinsurance penalty.
Coinsurance only comes into play on a partial loss. If you have a total loss (an amount equal to or higher than your building limit), coinsurance does not apply.
Tip: Coinsurance works as a carrot to help you avoid underinsurance amounts by purchasing a coverage amount at least 80% of the replacement cost. NOTE: Smart consumers buy an amount equal to the replacement cost. You’ll see why later.
(See, you’re smarter already! You now know that you don’t have to worry about coinsurance on a total loss.)
When do I have to worry?
On a partial loss silly.
How does it work?
How about we use an example?
I thought I was asking the questions?
Okay. Let’s do an example.
That’s better. I feel in control now.
That’s not a question.
Oops.
Okay. We’re back to normal. Here’s the example.
Client tells us they have a commercial building that they want to insure for $300,000.
Assume that the replacement cost is $600,000.
We advise the client that they should insure for the replacement cost, but the client says that they only owe $300,000 on their mortgage and to save money they want to use $300,000 as the building limit, as the bank says they will accept that amount.
Assume:
There is a $200,000 loss.
Building Replacement Cost (RC) $600,000
Building Insurance Limit $300,000
Coinsurance percentage 80%
Now, I will ask you the questions. How much will you get?
When do I get my $200,000 check?
How did you come up with that?
I had a $200,000 loss.
What about coinsurance?
What about it? I want my $200,000 check.
Most people would, but let’s see if the company owes you $200,000, Okay?
Is there going to be math involved?
Yes, but let me help you through it?
Somehow, I’m not feeling better.
What is the replacement cost on your building?
$600,000
What is your coinsurance percentage?
80%
What is $600,000 times 80%?
Hold on. Let me Google it.
Okay. Do you have the answer now?
$480,000
Correct. That wasn’t so hard was it?
No. When do I get my $480,000 check?
You know you’re not getting a $480,000 check, right?
Yes, but one can hope can’t one?
So $480,000 is the Building Limit you SHOULD have had to comply with the 80% coinsurance, right?
Yes?
Right, but how much Building coverage DID you have?
$300,000
Right again! So, you DID have $300,000 and you SHOULD have had $480,000, right?
If you say so.
I don’t say so, YOUR POLICY says so. Right?
Yes.
So how much are you getting for your $200,000 loss?
………………….$200,000???
Not hardly. You’re getting a percentage of the loss based on DID over SHOULD?
DID over SHOULD? What is this? Scrabble? Am I in a time-warp?
Sorry, you don’t get 4 questions.
That’s not a question!
You’re right, but you have to understand DID over SHOULD, Okay?
Okay.
When I say DID over SHOULD, the over means “divided by”. DID over SHOULD means the DID amount divided by the SHOULD amount. It would look like this:
DID $300,000
OVER
SHOULD $480,000
Means $300,000 = .625 (same thing as 62.5%)
$480,000
You then take your loss amount ($200,000) and multiply it by .625 which equals $125,000. Any questions?
I’m only getting $125,000 on my $200,000 loss?
Yes, but your deductible amount would then be deducted from that amount.
That’s a $75,000 penalty?
Yes. Remember coinsurance is designed to encourage you to insure adequately to replacement cost.
How could I have gotten paid for the whole $200,000 loss?
Insure at $480,000.
I thought if I insured at a certain amount that I got 100% of my loss UP TO MY BUILDING LIMIT? I thought if I insured at $300,000, that ANY loss up to $300,000 would be paid 100%?
Most people are under the same misconception.
You get 100% of your loss (up to your policy limit) by selecting a building limit equal to or greater than your coinsurance percentage times your building replacement cost amount.
Are there any other benefits of insuring at an amount equal to my coinsurance limit?
Yes. What if you had a total loss, instead of a partial loss?
Let me ask you a question.
Assume the same example info above, except you have a $600,000 total loss. How much would you get?
$600,000?
No, remember YOU chose a $300,000 limit. Guess again?
$300,000?
Yes! But wouldn’t you rather have had $600,000? Getting $300,000 when your builder is asking you for $600,000 to rebuild is not a good financial situation. What will you do?
I don’t know.
I don’t know either, but remember this. You still have a $300,000 loan on a building that is no longer there. Isn’t it likely that you would suffer foreclosure, bankruptcy or both?
Also remember that if you had insured 80% to replacement cost, at least you would have a limit of $480,000. That’s much closer to your $600,000 loss.
I guess I didn’t think it all the way through.
It happens to many people. We just don’t want it to happen to you and your family or business.