Exclusively from Foa & Son
Most folks who buy insurance have heard the term “coinsurance”, but few understand it. Part of the reason is that the word is used in both property insurance and in health insurance, but it means different things in each.
If you have 80% coinsurance on a claim from a health insurance policy it’s pretty straightforward….the insurance company pays 80% of the claim, you pay 20%. However, if you file a claim against a property insurance policy with an 80% coinsurance clause you’ll get paid 100 cents on the dollar up to the policy limit, as long as you carry limits sufficient to satisfy the coinsurance clause.
Here’s the background. Property insurance companies learned long ago that absent any other factors property insurance buyers as a rule would almost always tend to underinsure their properties, to carry an amount of insurance that would be less than the full value of the property insured. This stems from the common sense view that most property losses are partial losses; total losses are rare, and property insurance buyers know that. That’s particularly true on blanket policies covering many different structures. Why pay a premium for full limits you’re never likely to use?
This, however, is a problem for the insurance industry. Underwriters need an actuarially sound and consistent basis to measure exposure, track losses and determine rates. For property insurance in particular they need a common exposure basis; if one policyholder insures to 50% of value, another to 30%, another to 80% and so forth, there is no common basis. There is no way an underwriter can mash all those polices together to develop an actuarially sound and credible insurance rate.
Insurance companies solve this problem in property insurance by building in a clause that effectively forces policyholders to insure to a common base. This is the coinsurance clause, and it’s primary purpose is to enforce a consistent standard for actuarial and rating purposes.
An 80% coinsurance clause in a standard property policy simply means that the policyholder must carry an amount of insurance equal to 80% of the insurable value of the insured property. Other options are allowed; policyholders can also elect to insure to 90% or 100% of value, but insuring to less than 80% is not allowed. If the amount of insurance meets this test, any claim is paid in full up to policy limits. Carry less than the required amount and you’ll suffer a coinsurance penalty on any claim you might file. Your claim won’t be paid in full, your payment will be reduced in the same proportion as the shortfall in the required amount of insurance.
A coinsurance clause can be a problem for the policyholder, because the proper amount of required insurance is calculated at the time of loss, not when the policy is purchased. Buildings might be renovated, upgraded, added to. Building contents values may routinely fluctuate, often substantially; for a simple example of this just imagine a retail store that increases inventory before the holiday shopping season and then sees inventory shrink dramatically after the holidays. Under these very common conditions an insured that made a good faith effort to carry the proper amount of insurance when he bought the policy could nevertheless be shorted on a claim settlement.
Insurers overcame this by offering several options to deal with potential coinsurance problems. The most common is called an agreed value clause. With this, the underwriter can look at the amount of insurance requested and agree (hence the name, “agreed value clause”) at policy inception that it satisfies the coinsurance requirement. Should a loss occur, the adjuster proceeds directly to claim settlement with no need to calculate any possible coinsurance penalties.
The agreed value clause is an excellent way to eliminate any concern about possible coinsurance penalties. Most often the policy holder will be required to furnish a signed statement of the values insured to the underwriter. The underwriter will rely on this to provide the agreed value clause. Some care must be taken with this to be sure it is reasonably accurate and correct. If the statement of values contains material errors, unintentional or otherwise, the claim adjuster could still come back at the time of loss and allege material misrepresentation on the part of the policyholder. Insurance companies take a very dim view of this; it’s not something you want to deal with when you are trying to get a claim paid.
In summary, here are the steps anyone buying property insurance needs to follow to avoid problems at claim time:
1. Determine what basis of valuation you want to insure to. Replacement cost means current replacement cost, new property for old. Actual Cash Value (ACV) means replacement cost less physical depreciation. (Note this is not an accounting value, which is historical cost, depreciated.)
2. Based on the basis of valuation selected, determine the full value of the property to be insured.
3. Select a limit of insurance equal to 80%, 90%, or 100% of the full value.
4. If available or offered by your insurance company (some don’t or won’t), have an agreed value clause added to your policy.
Note that this is a simplified description. More needs to be done for a more complex property risk, one involving fluctuating values, multiple structures or locations, etc. We’ll be happy to work with you to get those properly covered.