You have received a quote for commercial property insurance which includes a coinsurance clause. You think you have a good grasp on the concept. After all, you have dealt with “coinsurance” when filing a claim on your personal health insurance. Why should coinsurance be different for commercial property insurance?
Well, I have news for you – it is.
When it comes to health insurance, coinsurance is straightforward. The designated coinsurance percentage tells you the portion of a claim that the insurance carrier will pay. You are responsible for the remaining portion. End of story.
The property insurance version is significantly more complex. A coinsurance clause for standard property insurance policies will dictate the limit that the policyholder needs to buy. If the policyholder purchases a limit of insurance lower than the specified percentage of the insured value, they’ll be hit with a reduced claim payout in the event they suffer a claim.
Understanding coinsurance and why it exists for property insurance is paramount for buyers. It will assist you in purchasing the right policy for your company and ensure that you are not blindsided by a lower claim payout than you are expecting.
How Does Coinsurance Work?
As we mentioned, a coinsurance clause gives a specified percentage – usually 80%, 90%, or 100%. Let’s say, your policy includes an 80% coinsurance clause. If your property is valued at $100,000 replacement cost, your policy limit needs to be at least $80,000. If you opt for a lower limit, any claim payout will be reduced by a penalty.
So, what’s the penalty? Let’s say in an effort to decrease the premium, you insured the aforementioned property at $75,000. A fire breaks out and results in a $20,000 loss. Because your $75,000 limit is below the coinsurance requirement of $80,000, your claim payout is penalized. The penalty is determined by dividing the limit of insurance purchased ($75,000) by the limit required by coinsurance ($80,000). This rate (0.93) is then multiplied by the loss amount ($20,000). In this example, you are paid out $18,750 for your $20,000 loss. Keep in mind that the loss recovery would be further decreased by any deductible or self-insured retention specified by the policy.
Still with me?
The short of what you need to know is that opting to insure your property for a limit lower than the full replacement cost value can be dangerous. Keep an eye out for it in your policy, and be sure that your limit meets the requirement. If not, your loss recovery may be less than you are expecting.
Why Does Coinsurance Exist?
It might seem like coinsurance is just another sneaky thing insurance companies can use in order to pay you less for your claims. That’s not true. Like any other complex insurance concept, coinsurance exists as the result of years of perfecting the product for both policyholders and insurers.
For a moment, let’s envision a world without coinsurance. Many buyers would try to save money by insuring their property for less than its replacement cost. After all, most property insurance claims are partial losses. Makes sense, right? Well to that I ask, what happens when a hurricane the likes of Harvey strikes and whole communities are wiped out? All of those businesses that were insured for only, let’s say, 50% of their property value may fail without the safety net of adequate insurance coverage.
Now let’s think from the perspective of insurers. The majority of policyholders are going to simply decrease their limit whenever they need premium relief in a world without coinsurance. As a result, insurers are going to raise rates to make up for the lack of premium coming their way. It is the few prudent business owners who rightly want to insure their full property value that are the ones that suffer from lofty property premiums in this scenario.
Thus, the coinsurance clause exists so that insurance buyers are incentivized to buy adequate insurance. When the majority of policyholders are purchasing full limits of insurance, more premium dollars are exchanged and insurers can lower rates to an equitable level. Coinsurance keeps the property insurance market balanced.
Knowing the value of your property is the key to staying in control of your insurance and avoiding any unwanted surprises. If you are a real estate owner, always have a recent appraisal on file and make sure you are using the right property valuation method (for more on this, check out our blog on replacement cost valuation).
Equipped with this information, you are in the driver’s seat to make an educated choice on your property insurance limit. It’s always a good idea to insure your property for its full value, but that may not always be the best choice for your business. Understanding the importance of staying within the confines of your coinsurance clause will ensure that your business is properly protected.
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