Property & Casualty Insurance Procurement & Litigation (9 of 10 Reoccurring Themes Every Lawyer Should Know)
Coinsurance is one of the most common insurance purchase misunderstandings. The coinsurance clause/penalty is a stated understanding and agreement within most property policies that requires the property owner to purchase insurance for a certain percentage of the full value of the property.
The trade-off is, if the property is insured to the required value, the insurance company will use the lowest possible rates for calculating premiums. However, if the property is not insured to the required amount, then partial claims (versus total losses) will be paid in a ratio of the amount insured divided by the amount that should have been insured multiplied by the partial loss. The Co-Insurance Penalty formula is: the amount insured, divided by the amount required to be insured, multiplied by the partial loss amount, equals the claim payment amount.
Example: Property is purchased for $120,000 (includes the land, which is not insured). The building on the property is 25 years old and has a replacement cost value of $100,000. There is a mortgage on the property for $50,000, and the mortgage company requires fire insurance coverage of at least that same amount. The owner buys a fire insurance policy with a limit of $50,000 and the policy has an 80% coinsurance clause. During the policy period, a fire occurs causing $20,000 in fire damage. How much will the insurance company pay? Answer: $12,500 (not $20,000.) Why? Amount insured ($50,000) divided by the minimum amount for which it should have been insured for ($80,000, which is 80% of $100,000) multiplied by the amount of the partial fire loss ($20,000) equals $12,500. This is a relatively easy calculation but a concept that is almost never understood by a claimant at the time of a loss.
Lesson #9: Do not allow your client (the insurance buyer) to confuse the price paid or the market value of property owned with the amount of insurance that should be purchased. If your client is not sure of the replacement cost or actual cash value on the property, have the insurance company determine it. There are ways to circumvent this problem. Your client may negotiate “Stated Amount Valuation” on the property coverages and have the “coinsurance clause” eliminated by endorsement.
ABOUT THE AUTHOR: David L. Stegall, Principal Consultant, Risk Consulting & Expert Services
David Stegall is the Principal Consultant at Risk Consulting & Expert Services. Mr. Stegall holds a B.A. in Communication from Auburn University and is a Chartered Property and Casualty Underwriter, an Associate in Risk Management and an Associate in Reinsurance, all awarded by The Institutes in Malvern, PA. He is also a Director of the Society of Risk Management Consultants.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.
