Insurance has a bad rap for being overly complicated and hard to understand. Co-insurance is one of those things in the insurance world that is at fault for this reputation. While co-insurance seems a little overwhelming at first, it’s an extremely important part of your insurance policy and worth taking the time to understand. To help you know exactly what you’re signing up for when you purchase an insurance policy, we’ve broken down the beast that is co-insurance.
What is Co-Insurance?
Many policies include a coinsurance clause. This clause requires policyholders (that’s you) insure your home/equipment/buildings…etc. to at least a specific percentage of the total replacement cost value. If you don’t, then your payout in the event of a claim will be penalized. Every policy is different, every insurance company is different, and while some policies may have an 80% co-insurance clause, others may have 90% or even 100%!
Why does Co-Insurance exist?
People tend to assume that if they experience a loss it won’t be a total loss, so why would they insure the total value of their property? If they only insure a portion of the value, they can save some money on their insurance and still be covered if a loss happens. Unfortunately this is incorrect. The purpose of insurance is to protect you from partial and catastrophic total losses. Insurers collect premium based on the total value of your property being insured, so that when catastrophic losses happen, the funds are available to pay out. This is why the co-insurance clause exists.
How does Co-Insurance work?
Let’s suppose that you own an office building downtown, and you consult with a contractor to determine that the replacement cost of your building is $2 million. Now, let’s say your insurance policy is subject to a 90% co-insurance clause. What you should do is insure the building on a commercial property policy to a minimum limit of $1.8 million. For example, let’s say a fire breaks out in the building and causes $700,000 in damages. If you’re insured to the co-insurance requirement, no co-insurance penalty will be applied to the settlement of your claim. But let’s say instead of insuring for $1.8 million, you only insure for $1 million, because you assume you’d never have a loss that exceeds $1 million in damages. If the policy is subject to a 90% co-insurance clause, the insurance company is going to look at what limit of insurance you hold on your policy, what the total replacement value of the building is, and whether your policy limit meets the 90% co-insurance limit required.
$2,000,000 x 90% = $1,800,000 is the minimum you should have insured the building to.
Since you’re underinsured, the insurance company is going to penalize your pay out by applying the co-insurance formula to your loss. This means they take what you DID insure to, divide this by what you SHOULD have insured to, and multiply this factor by your loss.
($1,000,000 / $1,800,000) x $700,000 = $388,889 would be the amount you get paid out.
Co-insurance is not something that only exists on commercial property policies. It can apply to your home and farm as well. Review with your broker to understand how co-insurance may affect you during a claim. Regularly reviewing the limits of insurance on your policy will make sure you don’t end up on the wrong side of the co-insurance formula.