Coinsurance is a provision in the insurance industry which allows an insurance company and its policyholder to potentially apportion between them any loss covered by the policy. This is usually according to a fixed percentage of the value for which the property is insured. In property insurance policies, the coinsurance clause provides that property must be insured for a specific percentage, usually 80% to 100% of its value. This means that the insurance company can shift part of the risk of loss back to the policyholder if the property is not insured to a certain ratio of the value of the property at the time of a loss. If the value of the property times the coinsurance percentage is greater than the limit of insurance for the property, then the insurer may apply a coinsurance “penalty” and may not pay the full value of that loss. Associations and all policyholders should periodically review their policies to determine if they are subject to a coinsurance percentage and to ensure that they are adequately insured for the value of their property according to any coinsurance percentage. This “penalty” can be huge for associations suffering a large loss in the event of a large catastrophe like a hurricane.
Typically, the insurance policy will explain the steps in calculating whether a “penalty” applies. It may be easiest to demonstrate how coinsurance works through hypothetical scenarios using some numbers. A policyholder has a policy providing $120,000 in coverage to the property, which is valued at $250,000. The policy has an 80% coinsurance provision reflected on the declarations page. If this property sustains a covered loss of $40,000, and has a $500 deductible, we would need to follow the steps pursuant to the policy to determine whether it is adequately insured to the agreed value, and whether a “penalty” would apply.
First, the value of the property at the time of the loss ($250,000) would be multiplied by the coinsurance percentage (80%), which equals $200,000. Next, divide the policy limit of insurance ($120,000) by the figure from step one ($200,000), which equals .60. Then multiply the total amount of the loss ($40,000) by the ratio from the second step (.60), which equals $24,000. In the last step, you would subtract any policy deductible ($500), which equals $23,500. Under this scenario, the property is not insured to the coinsurance percentage of 80% of the value of the property at the time of this loss so a “penalty” would apply and the insurer’s liability for that loss would be $23,500. The policyholder essentially would absorb the remaining $16,500 of the loss or would need to rely on other insurance for that portion of the loss. This is reflective of why it is referred to as a coinsurance “penalty.”
It is important for associations and all policyholders to periodically review their insurance policies with their insurance agents and professionals in the construction or risk management businesses to make sure they are adequately insured to the value of the property. Policyholders can even request that their insurance representatives check and confirm whether they would be subject to a coinsurance “penalty” under their policies if they were to sustain a covered loss at that time.