Learn more about coinsurance options.
What Is Coinsurance?
Many commercial property policies contain a coinsurance clause. This clause imposes a penalty when a policyholder suffers a loss and has failed to purchase an adequate insurance amount. In property insurance, coinsurance is based on the concept of insurance to value, meaning the ratio of your insurance limit to the value of your insured property. This means that you must purchase a policy limit that meets or exceeds the coinsurance percentage. If you have an 80% coinsurance clause and a building that would cost $1 million to replace, you must purchase at least $800,000 in coverage. Coinsurance is also used in medical and dental insurance. Many health and dental policies cover medical or dental costs according to a specified ratio such as 80/20 or 70/30. The larger number (80% or 70%) represents the percentage paid by the insurer for a covered service while the smaller number (20% or 30%) is the percentage the insured person must pay. Coinsurance clauses can also be found in some directors and officers and errors and omissions policies. These clauses may require you to pay a portion of any damages awarded or settlements.
How Coinsurance Works
Coinsurance clauses work by imposing a penalty on policyholders who fail to purchase enough insurance to satisfy the coinsurance percentage shown in their policy. The coinsurance clause has no effect unless there’s a property loss. If a loss occurs, the insurer will compare the insurance limit on your policy to the amount of insurance you were required to purchase based on the coinsurance percentage. If you purchased less than required, the insurance company might reduce your claim payment in proportion to the difference. If you purchased 10% less than required, the insurance company might pay 10% less. Coinsurance clauses encourage businesses to buy adequate insurance. If coinsurance clauses didn’t exist, some policyholders would try to save money on premiums by insuring their property for only a portion of its value. These policyholders would have insufficient insurance to cover large losses. For example, suppose that you own a small office building. After consulting a building contractor, you estimate the replacement cost of your building to be $2 million. You buy a property insurance policy with a 90% coinsurance clause. You insure the building for $1.8 million, which is 90% of the building’s replacement costs. Coinsurance clauses encourage policyholders to insure their property at or near its full value. When most policyholders buy full limits of insurance, insurers collect more premium dollars and can charge lower rates overall. This helps ensure property rates are equitable. In a commercial property policy, the coinsurance clause is typically found in the policy conditions section. The fact that your policy contains such a clause doesn’t mean that your policy is subject to coinsurance. Coinsurance applies only if a coinsurance percentage is shown in the policy declarations.
Alternatives to Coinsurance
One way to avoid a coinsurance clause is to purchase agreed value coverage. For this coverage option to apply, you must submit a statement of values to your insurer before the policy begins (or renews). The statement summarizes the value of your insured property, and the values may be expressed in terms of replacement cost or actual cash value, whichever you’ve selected. Agreed value coverage applies for the term of the policy. To continue the coverage to the following policy period, you must submit a new statement of values before your current policy expires. Another option for avoiding the coinsurance clause is value reporting. This option is typically used by businesses with property values that fluctuate due to changes in inventory. An example is a ski shop situated in an area popular for winter sports. You can choose quarterly, semi-annual, or monthly reporting and then submit reports of your property values at the required intervals.
