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COINSURANCE – DON'T FIND OUT THE HARD WAY
By Dan Weedin, CIC
If you’re a business owner, can you think of anything worse than a catastrophe that harms your business? But you’re OK because you have property insurance, right? How about discovering that the insurance company doesn’t think you insured your property for enough, so penalizes you by naming you a “coinsurer” on your claim? But, you explain, you have adequate limits to cover the loss. “Too bad, so sad,” says the company. You have a clause in your policy called coinsurance. Suddenly, bad has gone to worse, has gone to tragic. What happened?
Your claim doesn’t have to be of titanic size for you to be burned by coinsurance. Coinsurance can apply to losses of any amount. It’s actually as simple as 3rd grade math. Here’s how it works:
You own a building valued at $300,000 and have contents valued at $100,000. You have an 80% coinsurance clause on your policy. A fire damages your building to the tune of $150,000 and your contents at $50,000. Let’s forget the deductible for now and see how your policy responds.
The insurance adjuster comes out and informs you that in reality, your building’s replacement cost is $425,000 and the replacement cost of your contents is $250,000. How does this happen? It’s not too difficult when your agent hasn’t stopped in for awhile and, in the meantime, you’ve renovated your building, added to your equipment, and increased inventory because business has been good. While you were growing your enterprise, your policy just kept on renewing without any changes.
Back to the claim – The adjuster has bad news. Because your coinsurance is listed at 80%, you were required to carry at least 80% of the actual value of your property at the time of the loss or else be penalized. Here’s where the math comes in:
You insured your building for $300,000, but you should have insured it for $340,000 (80% of $425,000) according to the terms of your policy. The adjuster will take what you did buy ($300K), divide it by what you should have bought ($340K), and multiply that number (which is less than 1) by the loss ($150K). When you do the math, that comes out to roughly $132,000. All of a sudden, you are responsible for $18,000 of your loss on the building. Now, the contents. The contents were insured for $100,000 but should have been insured for $200,000 (80% of $250,000). Using the same formula, we divide $100K by $200K and multiply that number by $50K. After the numbers are crunched, it turns out that the company will pay about $25,000, or half the total loss on contents. Overall, you are left to be a “coinsurer” for $43,000 of your total $200,000 loss – a loss that you thought your policy limits were high enough to cover!
Think it doesn’t happen? Think again. Coinsurance penalties have been the misery of many a loss. Imagine if the damage were more extensive or the underinsured amount were even greater.
Remember, coinsurance is never a good thing for you, the policyholder. It benefits only the company. Some policies and nearly all businessowner policies remove coinsurance, but the majority of conventional property policies don’t. Make sure you understand how your policy responds to a coinsurance clause. What replacement value and coinsurance percentage does your property insurance show? Are they correct? Don’t wait for a disaster to find out.
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