2.3 Coinsurance and the Coinsurance Formula

Insurance-to-Value and the Coinsurance Clause

Most commercial property losses are partial, not total. To discourage insureds from buying low limits and gambling that no large loss occurs, property forms include a coinsurance clause requiring coverage equal to a stated percentage — commonly 80%, 90%, or 100% — of the property's full value at the time of loss. Carry less, and the insured becomes a "coinsurer" who shares the loss through a coinsurance penalty.

The Coinsurance Formula

The exam formula is exact — memorize it:

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

Where Should Carry = Property Value × Coinsurance %, and the result is capped at the policy limit. The ratio (Did ÷ Should) never exceeds 1.0 — carrying more than required does not increase a partial-loss payment beyond the actual loss, because indemnity bars a profit.

Worked Example — Underinsured

A building is worth $500,000. The policy has an 80% coinsurance clause, so the insured should carry $500,000 × 80% = $400,000. The insured actually carries only $300,000 and suffers a $100,000 loss with a $1,000 deductible.

• Did ÷ Should = $300,000 ÷ $400,000 = 0.75
• 0.75 × $100,000 = $75,000
• Minus $1,000 deductible = $74,000 paid

The insured absorbs $26,000 ($25,000 penalty + $1,000 deductible) for being underinsured.

When the Penalty Does NOT Apply

Two exceptions the exam tests. First, compliant insureds: if the insured carries at least the required amount (Did ≥ Should), the ratio caps at 1.0 and the full loss is paid up to the limit — no penalty. Second, total losses: on a total loss the policy simply pays the limit subject to valuation, so the coinsurance math is moot whenever the loss equals or exceeds the limit.

Two related rules round this out. Agreed Value coverage suspends the coinsurance clause entirely once the insurer accepts a signed statement of values. Homeowners policies use a distinct but parallel rule — the 80% replacement-cost requirement — where carrying at least 80% of full RC unlocks full RC settlement on partial losses; below 80%, a partial loss settles at the larger of ACV or the coinsurance-formula amount.

Second Example — 90% Coinsurance

A $1,000,000 building has a 90% coinsurance clause, so the insured should carry $900,000. The insured carries $720,000 and has a $200,000 loss with a $2,500 deductible.

• Ratio = $720,000 ÷ $900,000 = 0.80
• 0.80 × $200,000 = $160,000
• − $2,500 deductible = $157,500 paid

The insured eats the $40,000 penalty plus the deductible. Note the deductible is subtracted after applying the coinsurance ratio — order of operations is a classic trap.

Common Coinsurance Traps

• The deductible is subtracted after the coinsurance ratio is applied — never before.
• The Did÷Should ratio caps at 1.0; over-insuring never pays more than the actual loss (indemnity bars profit).
• Coinsurance is judged on value at the time of loss, not the value when the policy was written — inflation can silently push an insured below the required percentage.
• On a total loss, the clause is moot; the policy pays the limit (subject to valuation).

Homeowners 80% Rule Contrast

The HO policy uses a parallel but distinct 80% replacement-cost requirement. Carry at least 80% of full RC on the dwelling and partial losses settle at full RC up to the limit. Fall below 80% and the partial loss settles at the greater of ACV or the coinsurance-formula amount — never less than ACV. The exam contrasts the commercial coinsurance penalty (can drop below ACV) with the HO floor (never below ACV).

Worked 100% Coinsurance Compliant Case

A $600,000 building carries 100% coinsurance, so the insured should carry $600,000 and actually carries the full $600,000. A $150,000 loss occurs with a $2,500 deductible. Because Did ÷ Should = 1.0, no penalty applies: $150,000 − $2,500 = $147,500 paid. Compliant insureds always get the full loss up to the limit — the formula only bites when the insured under-carries.

Agreed Value Suspends the Clause

When the insurer accepts a signed Statement of Values and the Agreed Value option is shown on the declarations, the coinsurance clause is suspended for the term. The insurer pays the loss up to the limit without ever computing a Did÷Should ratio. This is the standard solution for insureds who want certainty on hard-to-value or high-value property and is the correct answer whenever a question asks how to eliminate coinsurance penalty risk.

Why Insurers Use Coinsurance

Because most losses are partial, an insured could buy a small limit, pay a small premium, and still be made whole on the typical small loss — shifting cost to fully-insured policyholders. The coinsurance clause corrects this by rewarding insurance-to-value: carry the required percentage and partial losses pay in full; carry less and share the loss. It aligns premium with exposure and is the economic rationale the exam expects you to articulate.

Blanket Coverage and Coinsurance

Under blanket limits covering multiple locations/items, the coinsurance requirement is applied to the combined value of all covered property, often using a Statement of Values to set the basis. This gives the insured limit flexibility across locations but still demands adequate total insurance-to-value. The interaction of blanket limits with coinsurance is a frequent advanced question.