Alyssa Lane
Coinsurance is a penalty imposed on the insured by the insurance carrier for under-reporting or under-insuring the value of their property. The penalty is based on a percentage stated within the policy and the amount under-reported. In the context of property insurance, coinsurance provisions often revolve around whether the insured value is greater than the limit of liability, with penalties imposed if the insured fails to meet the coinsurance requirement. The insured may then become a coinsurer and be responsible for a portion of the loss. The calculation of coinsurance penalties can be complex, and the interpretation of coinsurance provisions may depend on whether the insured has filed an actual cash value claim or a replacement cost claim.
| Characteristics | Values |
|---|---|
| Coinsurance definition | A penalty imposed on the insured by the insurance carrier for under-reporting/insuring the value of property |
| Basis for penalty calculation | Percentage stated within the policy and the amount under-reported |
| Coinsurance percentage | Usually 80% of the actual cash value |
| Coinsurance and insurance to value | Obtaining proper coinsurance and insurance to value can reduce the risk of underinsurance |
| Coinsurance and property insurance | A means for insurers to obtain rate and premium equality |
| Coinsurance and commercial property | The policy asks if the Required Insurance value is greater than the Limit of Liability |
| Required Insurance | Value of Covered Property multiplied by the Coinsurance percentage from the Declarations |
| Coinsurance and penalty | If the insured purchases insurance less than the coinsurance percentage, they will be penalized in the event of a loss and become a coinsurer |
| Coinsurance and claim type | The interpretation of the coinsurance provision varies depending on whether the insured has filed an actual cash value claim or a replacement cost claim |
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What You'll Learn
Coinsurance and replacement cost
Coinsurance is a clause in insurance policies, often commercial property insurance, that requires the insured party to maintain coverage equal to a certain percentage of the value of the property. This percentage is known as the coinsurance percentage. If the insured party does not meet this requirement, they may be penalised in the event of a loss and will become a coinsurer.
The value of the property can be determined in two ways: the replacement cost or the actual cash value. The replacement cost is the amount it would take to replace or repair the property with materials of similar kind and quality, without deducting for depreciation. The actual cash value is the replacement cost minus depreciation.
In the event of a loss, the insurer will pay the full value of the loss (either the replacement cost or the actual cash value, depending on what the insured has purchased) less the deductible, up to the limit of insurance. The deductible is subtracted from the final payment amount after the coinsurance percentage has been applied.
Coinsurance disputes are on the rise due to properties being underinsured. This is partly due to the recent inflation of construction costs. It is important for property owners to regularly re-evaluate their property values and adjust their insurance limits accordingly to avoid underinsurance and the consequences that come with it, such as coinsurance penalties.
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Coinsurance penalties
Coinsurance is a property insurance provision that imposes a penalty on an insured person's loss recovery if the limit of insurance purchased is not at least equal to a specified percentage of the value of the insured property. In other words, coinsurance penalties are triggered when a policyholder has not purchased enough insurance to cover a required amount of the value of their insured property.
The valuation method used for covered property to drive the coinsurance penalty should be consistent with the valuation method of the total amount of loss. Coinsurance penalties can be avoided by ensuring that the value of a business's buildings and business personal property is correctly valued by utilizing the insurance carrier's loss control staff. It is important to insist that these carrier employees inspect and value the property and that both parties agree on those stated values when the policy is issued or renewed.
A coinsurance clause is a provision in a property insurance policy that penalises the insured's loss recovery if the limit of insurance purchased by the insured is not at least equal to a specified percentage of the value of the insured property. For example, a building valued at $1,000,000 with an 80% coinsurance clause that is insured for only $750,000 will be subject to an underreporting penalty. In the event of a $200,000 loss, the insurance payout will be calculated as follows: $750,000 / (0.80 x 1,000,000) x 200,000 = $187,500 payout (less any deductible).
In the case of Buddy Bean Lumber Co. v. Axis Surplus Insurance Co., the Eighth Circuit addressed whether under Arkansas law a coinsurance provision should be applied to the actual cash value or replacement cost of the covered property. The court concluded that the proper interpretation of the coinsurance provision varied depending on whether the insured had filed an actual cash value claim or a replacement cost claim.
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Actual cash value claims
Actual cash value (ACV) is the amount equal to the replacement cost minus depreciation of a damaged or stolen property at the time of the loss. It is computed by subtracting depreciation from the replacement cost. Depreciation is figured by establishing an expected lifetime of an item and determining what percentage of that life remains. This percentage, multiplied by the replacement cost, provides the actual cash value.
When you file an insurance claim, an insurance adjuster will get involved to determine the cost of your claim. If you have agreed to value your covered items at actual cash value, the adjuster will determine how much it currently would cost to replace your lost or damaged item with a similar item, and then subtract the loss in value due to depreciation from that amount.
Many home insurance policies use actual cash value as the default method of claim payments. Actual cash value home insurance policies offer limited coverage compared to replacement cost value policies because depreciation is factored into your claim payout. However, actual cash value home insurance policies typically cost less than replacement cost policies.
If the insured purchases insurance at least equal to the coinsurance percentage (say 80 percent), the insurer pays the full value of any loss (either replacement cost or actual cash value, depending on what the insured has purchased), less the deductible, up to the limit of insurance. If the insured does not meet the coinsurance requirement, they will be penalized in the event of a loss and will become a coinsurer.
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Coinsurance and property insurance
Coinsurance is a clause in a property insurance policy that requires the insured party to maintain coverage on their property up to a certain percentage of its value. This is done to ensure that the insured party has "skin in the game" and to reduce the risk of underinsurance. The coinsurance percentage is typically set at 80%, but can vary depending on the insurer and the specific policy. If the insured party does not meet the coinsurance requirement, they may be penalized in the event of a loss and will become a coinsurer.
In the context of property insurance, coinsurance is used as a risk-sharing technique by the insurer. It allows insurers to obtain rate and premium equality by applying expected losses based on past loss experience over an entire underwriting book. The exposure base, which includes the total insured value for the building, contents, and business income, is used to determine the coinsurance percentage.
The coinsurance percentage is important in determining the payout in the event of a loss. If the insured party has met the coinsurance requirement, the insurer will pay the full value of the loss, less any deductible, up to the limit of insurance. However, if the insured party has not met the coinsurance requirement, they may be subject to a reduced payout or penalty. The formula used to determine the amount payable when a coinsurance provision applies is: Insurance Carried x Loss = Amount Recoverable Insurance Required (Insurance carried, divided by insurance required, multiplied by the loss, equals the amount recoverable).
Coinsurance clauses may differ by insurer, especially if using an independently filed policy form, so it is important for the insured party to carefully review their policy to understand the specific coinsurance requirements and potential penalties. In some cases, the valuation method used for Covered Property to drive the Coinsurance penalty may differ from the valuation method of the total amount of the loss, and the insured may have the option to pursue an Actual Cash Value (ACV)-based measurement to maximize its recovery.
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Coinsurance and underinsurance
Coinsurance is the amount an insured party must pay for claims after exceeding their deductible. It is typically expressed as a fixed percentage and is the portion of the loss that the policyholder is responsible for after the deductible has been met. One of the most common coinsurance breakdowns is the 80/20 split, where the insurer pays 80% and the insured pays 20%.
Coinsurance clauses are included in most property insurance contracts. These clauses require the policyholder to insure their property for a certain percentage of its total cash or replacement value. Failure to insure your property for its replacement value can result in being underinsured and trigger coinsurance in the event of a claim. For example, if a property is insured for $200,000 but costs $300,000 to rebuild, and the policy has a 90/10 coinsurance clause, the insured party will be responsible for a larger portion of the loss.
The valuation method used for covered property to determine the coinsurance penalty should be consistent with the valuation method of the total amount of the loss. The insured may have the option to pursue an actual cash value (ACV) or replacement cost value (RCV) measurement, depending on the type of claim filed. If the insured purchases insurance at least equal to the coinsurance percentage, the insurer pays the full value of any loss (either replacement cost or actual cash value) up to the limit of insurance.
Underinsurance refers to the situation where the insurance limits are not sufficient for the structure being insured. This can affect the claim payout for any size of loss due to the coinsurance clause. Being underinsured can result in a reduced claim payment, proportional to the coverage deficiency. To mitigate the risks associated with underinsurance, brokers and insureds must work together to ensure that policies reflect the true replacement cost.
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Frequently asked questions
Coinsurance is a penalty imposed on the insured by the insurance carrier for under-reporting/insuring the value of their property. The penalty is based on a percentage stated within the policy and the amount under-reported.
Coinsurance divides the risk of loss according to the amount of insurance purchased by each person through the payment of premiums. The size of insurance premiums is based primarily upon the value of the property covered by the policy.
To avoid a coinsurance penalty, ensure that all of your property is insured for at least the coinsurance percentage (e.g. 80%) of its actual replacement cost value.
Replacement cost is the cost to replace the property, whereas actual cash value is the replacement cost less depreciation.
