How Co-Insurance Works: A Step-by-Step Explanation

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.

Co-insurance is a staple concept within many insurance policies that, when properly understood, can significantly affect your financial responsibilities during a claim. Its role and impact extend far beyond a simple clause in your policy, influencing both your premiums and out-of-pocket expenses in the event of an insured loss. This makes it an essential piece of knowledge for anyone looking to safeguard their assets effectively.

Calculating Co-insurance and Its Impact on Claims

The Co-insurance Formula

Co-insurance involves a clause in your insurance policy that is crucial to understand, as it directly affects the amount you might receive in a claim. This clause requires that the amount of insurance you’ve purchased, known as the limit of insurance, must meet or exceed a specified percentage of the value of the insured property. For instance, if there’s an 80% co-insurance requirement on your building, you need to have insurance coverage that is at least 80% of the building’s value. Failing to meet this requirement could lead to reduced claim payments proportional to the shortfall in coverage.

The formula to check if your coverage meets the co-insurance requirement is Value of the property x Co-insurance percentage = Minimum insurance amount required.

Examples of Co-insurance Calculations

To illustrate how co-insurance calculations work, consider two scenarios:

1. Scenario 1: Co-insurance requirement is met – If the value of your building at the time of loss is $100,000, with a co-insurance percentage of 90%, your limit of insurance should be at least $90,000. Meeting this requirement means the full amount due on a claim is payable minus the deductible. For example, if the cost to repair covered damage is $20,000 and the deductible is $500, the amount payable based on Replacement Cost Value (RCV) is $19,500.
2. Scenario 2: Co-insurance requirement is not met – If the limit of insurance is only $45,000 against the same building value and co-insurance percentage, the insurance purchased is only 50% of the required amount. Thus, coverage for repair costs is also limited to 50%. If the repair cost is $20,000, only $10,000 (50% of the repair cost) is covered, leading to a payable amount of $9,500 after considering the deductible.

Penalties for Underinsuring

Underinsuring your property can lead to penalties known as co-insurance penalties. These are essentially reductions in claim payments when you fail to maintain coverage at a specified percentage of your property’s value. For example, if your property is insured for less than the required 80% or 90%, you become a “co-insurer” and will share the loss with the insurance company according to the co-insurance formula.

The penalty is calculated by dividing the actual amount of insurance by the amount that should have been carried, then multiplying by the amount of the loss. This results in a reduced reimbursement, which can be a significant financial burden in the event of a claim. It’s a stark reminder of the risk of retaining part of the risk yourself by not adhering to the co-insurance clause.

In summary, understanding and adhering to the co-insurance requirements in your policy is crucial. It ensures you are adequately covered and prevents financial surprises in the event of a claim. Regularly reviewing your policy limits and property values with your insurance agent can help avoid the pitfalls of underinsurance and the associated penalties.

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. Insurance aims to protect you from partial and catastrophic total losses. Insurers collect premiums 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.

Co-insurance is not something that only exists on commercial property policies. It can apply to your home and farm as well. The primary goal of co-insurance is to involve you more actively in managing and mitigating your risks and costs. Insurance companies aim to discourage underinsuring and prevent moral hazard by sharing the cost burden, contributing to keeping premiums more affordable.

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