2.3 Coinsurance and the Coinsurance Formula

Why Coinsurance Exists

Most property losses are partial, not total. Without an incentive, insureds would underinsure — buying a small limit and gambling that no total loss occurs — which would force carriers to raise rates on everyone. The coinsurance clause corrects this by requiring the insured to carry a limit equal to a stated percentage of replacement cost (commonly 80%, sometimes 90% or 100%). Meet the requirement and partial losses are paid in full (less the deductible); fall short and the insured shares — or co-insures — the loss through a penalty.

The higher the coinsurance percentage selected, the lower the rate per $100 of coverage, because the carrier knows the building is more adequately insured. Insureds therefore trade a higher required limit for a cheaper rate — a classic exam reasoning point.

The Coinsurance Formula

The exam formula — memorize it exactly — is:

Payment = (Did Carry ÷ Should Carry) × Loss − Deductible

• Did Carry = the limit actually purchased
• Should Carry = replacement cost × coinsurance percentage
• The result is capped at the policy limit; it is never more than "Did Carry."

A shortcut: if Did Carry equals or exceeds Should Carry, the ratio is 100% (treat it as 1, never more than 1) and the loss is paid in full up to the limit. The penalty appears only when Did Carry is less than Should Carry.

Worked Example — Underinsured

A building has a replacement cost of $500,000 with an 80% coinsurance clause. The insured carries $300,000 and suffers a $100,000 loss (no deductible for clarity).

• Should Carry = $500,000 × 80% = $400,000
• Did Carry = $300,000
• Payment = ($300,000 ÷ $400,000) × $100,000 = $75,000
• The insured absorbs the remaining $25,000 as the coinsurance penalty.

Worked Example — Compliant

Same building, but the insured carries $400,000 (exactly 80%):

• Should Carry = $400,000; Did Carry = $400,000
• ($400,000 ÷ $400,000) × $100,000 = $100,000 — paid in full.

Carrying more than required does not pay more than the actual loss; coverage still caps at the loss amount and the policy limit. Over-insuring simply wastes premium.

Compliance and Payment Table

With a Deductible

Apply the ratio first, then subtract the deductible. Using the underinsured case with a $2,500 deductible: ($300,000 ÷ $400,000) × $100,000 = $75,000, then − $2,500 = $72,500. Reversing the order (deductible first) is a classic wrong answer planted in the options.

Suspending or Avoiding Coinsurance

• Agreed value endorsement — suspends the clause entirely (see 2.2); the insurer accepts the stated value and waives the ratio test.
• Total losses — the penalty cannot reduce a payment below the policy limit on a total loss subject to the limit; the limit is paid in full.
• Many homeowners policies waive coinsurance if the dwelling is insured to at least 80% of replacement cost at the time of loss, paying RCV; below 80%, settlement drops to the larger of ACV or the proportional (replacement-cost) amount.

Common Traps

• Coinsurance is judged at the time of loss, using replacement cost, not market value or original cost.
• The penalty applies to partial losses; a true total loss to the limit pays the limit.
• Do not subtract the deductible before applying the ratio — ratio first, deductible last.
• A higher coinsurance percentage lowers the rate, not the dollar limit required.

Commercial Coinsurance and Time-Element Coverage

Coinsurance is not limited to buildings. The Business Income (and Extra Expense) coverage form uses a coinsurance percentage applied to the 12-month income the business would have earned, requiring the insured to carry a limit equal to that percentage (often 50%–125%) of expected income. Underestimate the figure and the same penalty math applies to a business-interruption claim.

Some commercial insureds avoid the calculation entirely by selecting the Monthly Limit of Indemnity, Maximum Period of Indemnity, or Agreed Value options, which suspend coinsurance in exchange for different limiting mechanisms. Expect the exam to extend the coinsurance ratio beyond a simple building example, so practice the formula until it is automatic regardless of the property class involved.

The Coinsurance Formula, Step by Step

The coinsurance clause penalizes underinsurance. The formula is:

Payment = (Amount Carried ÷ Amount Required) × Loss − Deductible, capped at the loss and the limit.

The Amount Required = coinsurance % × the property's value at the time of loss. If the insured carries at least the required amount, there is no penalty (the did/should ratio is 1.0 or higher).

Worked example: a building worth $500,000 carries an 80% coinsurance clause, so the required amount is $400,000. The insured carries only $300,000 and suffers a $100,000 loss. Payment = ($300,000 ÷ $400,000) × $100,000 = $75,000. The insured absorbs the $25,000 coinsurance penalty for being underinsured.

Why Coinsurance Exists and Common Variations

Most losses are partial, so without coinsurance an owner could insure to a small fraction of value, pay a tiny premium, and still collect on likely small losses — shifting cost unfairly to fully-insured policyholders. Coinsurance rewards insuring to value with a lower rate per $100 and penalizes those who do not.

Key points the exam tests:

• The penalty applies only to partial losses; if the building is a total loss, the insured collects only the limit anyway, so the penalty is moot beyond the limit.
• A higher coinsurance percentage (90% or 100%) means a lower rate but a stricter requirement.
• An Agreed Value endorsement suspends coinsurance — the insurer accepts a stated value and waives the penalty.

Quick Answer: Coinsurance penalty = (did carry ÷ should carry) × loss; it bites only on partial losses and is waived by an Agreed Value endorsement.