Coinsurance and Insurance to Value

Coinsurance is one of the most important — and most tested — concepts in property insurance. Failure to understand coinsurance can result in devastating financial consequences for policyholders.

What Is Coinsurance?

Definition: A provision requiring the insured to carry coverage equal to a specified percentage of the property's value. If this requirement isn't met, the insured shares proportionally in every loss.

Common Coinsurance Percentages:

• 80% — Most common for property
• 90% — Sometimes required for replacement cost
• 100% — Full value coverage required

Think of it this way: If you don't insure your property adequately, you become your own insurer for the portion you should have covered.

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Why Coinsurance Exists

Without coinsurance, there's a problem:

Scenario: A $500,000 building owner knows most fires cause partial losses (say, $50,000). They might:

• Buy only $100,000 coverage
• Pay lower premiums
• Collect full amount on most partial losses
• Leave insurer with inadequate premium for the actual risk

Coinsurance prevents this by penalizing underinsurance on ALL losses, not just total losses.

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The Coinsurance Formula

When a loss occurs, here's how payment is calculated:

Formula:

Claim Payment = (Amount Carried ÷ Amount Required) × Loss

But the payment can NEVER exceed:

• The actual loss, OR
• The policy limit (whichever is less)

Breaking It Down:

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Coinsurance Example 1: Meeting the Requirement

Given:

• Building value: $500,000
• Coinsurance requirement: 80%
• Policy limit: $400,000
• Loss: $100,000

Calculation:

• Amount Required: $500,000 × 80% = $400,000
• Amount Carried: $400,000
• Ratio: $400,000 ÷ $400,000 = 100% (requirement met!)

Claim Payment: ($400,000 ÷ $400,000) × $100,000 = $100,000 (full loss paid)

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Coinsurance Example 2: Coinsurance Penalty

Given:

• Building value: $500,000
• Coinsurance requirement: 80%
• Policy limit: $300,000 (underinsured!)
• Loss: $100,000

Calculation:

• Amount Required: $500,000 × 80% = $400,000
• Amount Carried: $300,000
• Ratio: $300,000 ÷ $400,000 = 75% (short by 25%!)

Claim Payment: ($300,000 ÷ $400,000) × $100,000 = $75,000

Penalty: The insured only receives $75,000 of a $100,000 loss — a $25,000 penalty for being underinsured!

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Coinsurance Example 3: Loss Exceeds Limit

Given:

• Building value: $1,000,000
• Coinsurance: 80%
• Policy limit: $700,000
• Loss: $900,000

Calculation:

• Amount Required: $1,000,000 × 80% = $800,000
• Amount Carried: $700,000
• Ratio: $700,000 ÷ $800,000 = 87.5%

Formula Result: 0.875 × $900,000 = $787,500

But Wait! Payment cannot exceed the policy limit.

Actual Claim Payment: $700,000 (policy limit)

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Avoiding the Coinsurance Penalty

Option 1: Carry Adequate Coverage

Maintain at least 80% (or required %) of property value.

Challenge: Property values change — must review annually.

Option 2: Agreed Value Clause

Pre-agree on property value with insurer:

• Eliminates coinsurance penalty
• Value established at inception
• Usually requires annual statement of values

Option 3: Inflation Guard Endorsement

Automatically increases coverage to keep pace with inflation:

• Annual percentage increase (often 4-8%)
• Helps maintain adequate coverage
• Doesn't guarantee meeting coinsurance

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Insurance to Value (ITV)

Formula: ITV Ratio = Amount of Insurance ÷ Property Value

Example:

• $400,000 coverage on $500,000 property
• ITV = $400,000 ÷ $500,000 = 80%
• Meets 80% coinsurance requirement

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Key Exam Points

1. Coinsurance applies to partial losses, not just total losses
2. Payment never exceeds the lesser of the loss or policy limit
3. 80% coinsurance is the most common requirement
4. Agreed Value eliminates coinsurance penalty
5. The penalty affects the insured — they become a "co-insurer"