If you own property, periodically making sure it’s adequately insured is critical. Most people don’t want to be in a situation where they aren’t fully compensated for a claim. But how do you know how much insurance you need, and what happens if your property is underinsured? That’s where coinsurance comes in.
Coinsurance is a term used to describe the sharing of risk between the insurer and the insured. When it comes to property insurance, coinsurance means that you agree to insure your property for a certain percentage of its value, and if you don’t, you financially share in a larger portion of any claims that arise.
The main purpose of coinsurance, as it pertains to property (building, homes, equipment, etc.) is to encourage, and hold the insured responsible to adequately insure their property. There is a minimum insurance to value (ITV) you need to insure your property for, in-order to avoid being essentially penalized for underinsuring.
Typically, homeowners policies have an 80% coinsurance requirement. Meaning you need to insure your home for at least 80% of it’s estimated replacement value, to avoid being penalized. Some commercial properties are 90%, or even 100%!
Insurance companies assess coinsurance to avoid situations where they are not collecting the right amount of premium for the loss they may have to pay. Ultimately, It’s not fair for someone who underinsures and pays less premium to get the same benefit as someone who insures properly and pays the appropriate premium.
Here’s a scenario:
Lorraine and Kyle both own a strikingly similar home across the street from each other in the same neighborhood. They are both insured with the same insurance company, X-Ray Insurance. X-Ray Insurance has determined both homes have a total replacement value of $100,000
Both home policies also include an extended replacement cost endorsement. This means that X-Ray insurance would pay up to 125% of their current replacement value for a total loss, for a maximum coverage amount of $125,000. This is useful, as it makes sure theres an extra bucket of money available if the $100,000 was not enough to rebuild the homes after a total loss. The important thing to know here is that unless you have met your coinsurance requirement, the replacement cost endorsement is essentially void and will not apply.
Assuming there is a typical, 80% coinsurance clause on the homeowners policies, Lorraine and Kyle need to insure their homes for at least $80,000 in order to avoid being penalized.
- Lorraine insures her property for 100% of it’s current, estimated replacement value of $100,000 which her agent and the insurance company helped her calculate.
- Kyle instead chooses to insure his home for $50,000 in an effort to get a cheaper homeowners policy. He figures that because he has the replacement cost endorsement, he can get a cheaper policy by insuring the home for less, and will still get paid up to $125,000 towards rebuilding his home.
- Both homes suffer windstorm damage and have $40k in damages
- X-Ray Insurance has an 80% coinsurance requirement
- Because Lorraine insured her home for at least $80,000, X-Ray Insurance will pay the $40,000 claim to repair her home.
- Kyle however, will suffer a coinsurance penalty for underinsuring his home.
Coinsurance penalty’s are calculated like this.
The amount you actually insured your home for, divided by the minimum amount you should have insured it for determines the percentage of coverage that you carried relative to the minimum amount of coverage required.
In most cases, if this percentage is more than 80% your done and don’t need to worry about a penalty.
If it’s lower than 80%, coinsurance penalties may apply. To determine the penalty the following formula is applied.
Did insure / should have insured, X claim amount, – the deductible. = amount company pays out.
In Kyles case, he should have insured his home for at least 80% of $100k, or $80,000. He insured it for $50,000
- $50,000/$80,000 = .625 or 62.5%
- 62.5% X 40,000 = $25,000
- deductible is $1,000
- Payment to Kyle is $24,000
In this scenario, Kyle will need to pay the difference of $16,000 out of pocket and you can see why underinsuring has huge risks.
Coinsurance doesn’t only apply to homeowners insurance, it applies in all sorts of property insurance policies. From equipment, to commercial building policies, coinsurance is a condition in most of them.
The important thing to remember is that you just need to insure property for it’s accurate replacement value. So long as you’ve provided the correct info about the property value in good-faith, you’ll likely be okay and avoid a coinsurance penalty.
- This is why agent asks you about things like purchase price, square feet, number of bathrooms, type of roof, additional features, etc.. It’s to make sure your covered properly.
Bottom line is that coinsurance can be confusing. If you have questions, or want to make sure your properly insuring your property, reach out to your agent, or contact us for help.