Coinsurance is one of the most misunderstood terms in the insurance industry. However, when broken down with examples, it becomes much easier to understand.
What is the Coinsurance Clause?
The coinsurance clause is a common aspect of many commercial property insurance policies. It acts as an incentive for policyholders to purchase coverage that closely matches the full value of their properties. If a business underestimates its property’s value or does not purchase enough coverage, it may not receive the full claim payout in the event of a loss.
During the underwriting process, insurance carriers use a property’s value to determine key policy details, such as:
- Premiums
- Coverage limits
- Deductibles
Since inaccurate property values can put insurers at financial risk, the coinsurance clause shifts some of this risk back onto policyholders by applying penalties when coverage falls short of the required minimum.
Why is Coinsurance Important?
Without meeting the minimum coverage requirement, businesses may not receive enough funds to rebuild after a major loss. Additionally, failing to meet the coinsurance requirement affects all claim payouts, reducing the amount policyholders receive for damages.
Most policies require businesses to carry at least 80% of their property’s value in coverage. If a claim is submitted and an inspection reveals that the coverage falls below this threshold, the insurance payout is reduced accordingly.
How is Coinsurance Calculated?
Insurance carriers determine a property’s value based on an appraisal conducted after a claim is filed—not on the figures provided by the policyholder during underwriting. This means any changes in property value over time could impact how much coverage is required under the coinsurance clause.
A coinsurance penalty is applied when the coverage purchased is less than the required percentage of the property’s value. Let’s look at two examples:
Example 1: No Coinsurance Penalty
- A business owner purchases a commercial property policy with $900,000 in coverage.
- The policy has an 80% coinsurance requirement.
- After a fire causes $200,000 in damage, an inspection determines the actual property value is $1 million.
- Because the policy’s limit ($900,000) exceeds the 80% minimum requirement ($800,000), the insurer pays the full claim amount of $200,000.
Example 2: Coinsurance Penalty Applies
- The same business owner purchases $600,000 in coverage instead.
- The property is still worth $1 million, requiring at least $800,000 in coverage per the 80% coinsurance clause.
- Because the coverage purchased is only 75% of the required amount ($600,000 instead of $800,000), the insurer will reduce all claim payouts by 25%.
- If the fire damage totals $200,000, the insurer only pays $150,000 due to the penalty.
Avoiding Coinsurance Penalties
To ensure your business has adequate coverage and avoids penalties:
- Conduct regular property appraisals to maintain accurate values.
- Work with an insurance professional to ensure your policy meets required coverage limits.
- Periodically review and update your policy as property values change.
Get the Right Coverage for Your Business
Understanding the coinsurance clause helps you avoid costly penalties and ensures your business is adequately protected. If you have questions about your commercial property policy, our team is here to help.
Need expert guidance? Contact us today for assistance with your insurance and risk management needs.
