Insuring your property for less than the coinsurance clause requires is not a good plan. It’s an opening to massive downside risk. Coinsurance can be tricky, and it’s definitely not a one-size-fits-all situation. It’s extremely important that you understand the potential for risk exposure. If you have a property coinsurance clause, always insure to the requirements and review your policy often.
The Coinsurance Clause
Coinsurance is the minimum amount of coverage that an insurer requires a policyholder to carry on their commercial property. Coinsurance is based on a percentage of the replacement cost of the property, which is valuated at the time the policy is enacted. There is a coinsurance penalty to be paid if the coinsurance clause is not met. That coinsurance penalty is paid by the policyholder as an out-of-pocket expense. Coinsurance penalties are designed to encourage property owners to carry adequate insurance to replace the property in the event of a catastrophic loss.
Full Replacement Cost
When insuring property, think of everything that would need to be replaced to get you back to what you originally had. The cost of construction to rebuild or replace everything from the ground up. Labor and materials are valuated at the time of the loss, using present-day costs.
Don’t confuse property value with replacement cost. Property value is determined by the market where a buyer would pay for something from a seller.
Property Value vs. Full Replacement Cost
Insurance is intended to offset or transfer risk from the policyholder to the insurer. The insurer will “make whole” the policyholder. When buying property insurance, property limits are to be insured to full replacement cost. That way, when repair or rebuilding takes place, you’ll be restored to what you had before the loss or “made whole.”
Note: It’s important to consider your property in terms of a total loss. From the structure of the building to the contents, including artwork, furnishings, collectibles, flooring, windows, wallpaper or paint. How much would it cost to start over? Even if you only need to repair a partial loss, it’s calculated within the overall coinsurance replacement value.
Coinsurance Penalty Scenario 1: Underinsured to Reduce Premiums
Some policyholders choose to insure their property for lower than the percentage that the coinsurance clause requires. Policyholders see this as a way to save money on reduced premiums. But, this is not a good plan and it’s an opening to massive downside risk.
Coinsurance Penalty Scenario 2: Underinsured Due to Replacement Cost Valuation
The full replacement cost is determined at the time the policy is enacted. When a loss occurs, the full replacement cost is valued again. Assume that the cost of construction materials, labor, etc., goes up over time. What cost $3.5M to replace ten years ago may cost $5M today. Since the full replacement cost may have increased since the original valuation, the coinsurance gap widens. If you have not increased your insurance coverage to keep pace with replacement cost, your coinsurance penalty will kick in. The end result is an even larger out-of-pocket expense.
How We Can Help You
Call us! We’ve been protecting businesses for nearly 100 years. We’ll talk to you about your business properties and figure out your risk. We’ll shop the insurance companies for you and get back to you with a quote that best protects your assets, now and in the future. It’s just one more way we’re your partner in navigating risk.
* Out-of-Pocket Calculation Scenario 1
(Valuation of the property * Coinsurance % Required) = $ amount the insurance company requires
(Amount carried on policy/Amount insurance company required) = % the insurance company will cover
(Cost of the damage * % the insurance company will cover)
($3.5M * 90%) = $3.15M – amount the insurance company requires in coverage when the replacement cost amount is determined, at the time of loss
($3.5M * 80%) = $2.8M – amount carried on the actual policy, when it was written
($2.8M/$3.15M) = 89%
($1M * 89%) = $890,000 is what the insurance company pays to policyholder for loss expenses
($1M – $890,000) = $110,000 is what the policyholder pays out-of-pocket for loss expenses
* Out-of-Pocket Calculation Scenario 2
($5M * 90%) = $4.5M – amount the insurance company requires in coverage when the replacement cost amount is determined, at the time of loss
$3.5M – amount carried on the actual policy, when it was written (with no increase in coverage limits in ten years)
($3.5M/$4.5M) = 78%
($1M * 78%) = $780,000 is what the insurance company pays to policyholder for loss expenses
($1M – $780,000) = $220,000 is what the policyholder pays out-of-pocket for loss expenses