2.3 Coinsurance and the Coinsurance Formula

Why Coinsurance Exists

Most losses are partial. If insureds could buy small limits and still collect on every partial loss, premiums would be unfair to those who insure to full value. Coinsurance is a property condition that requires the insured to carry a limit equal to a stated percentage of value (commonly 80%, 90%, or 100%). Insure to that percentage and partial losses are paid in full (less the deductible). Underinsure, and the insured becomes a co-insurer and shares the loss.

The Coinsurance Formula

The penalty calculation is the single most-tested numeric on the property exam. Memorize it as "Did / Should":

Loss Payment = (Limit Carried ÷ Limit Required) × Loss − Deductible

where Limit Required = Property Value × Coinsurance %.

• The fraction (Did ÷ Should) can never exceed 1.00 — you do not get more than the loss for over-insuring.
• Payment is also capped at the policy limit.

Worked Example — Underinsured

A building is worth $500,000 with an 80% coinsurance clause. The required limit is $500,000 × 0.80 = $400,000. The insured carries only $300,000. A $100,000 loss occurs with a $1,000 deductible.

1. Did ÷ Should = $300,000 ÷ $400,000 = 0.75
2. Apply to loss: 0.75 × $100,000 = $75,000
3. Subtract deductible: $75,000 − $1,000 = $74,000

The insured absorbs the $25,000 coinsurance penalty plus the deductible because the building was underinsured.

Worked Example — Properly Insured

Same $500,000 building, 80% coinsurance, but now the insured carries the full $400,000 required limit. A $100,000 loss occurs with a $1,000 deductible.

1. Did ÷ Should = $400,000 ÷ $400,000 = 1.00
2. Apply to loss: 1.00 × $100,000 = $100,000
3. Subtract deductible: $100,000 − $1,000 = $99,000

Meeting the coinsurance requirement means no penalty — only the deductible reduces the payment.

Choosing a Coinsurance Percentage

Insureds trade premium for penalty risk when they pick a coinsurance percentage. ISO grants a coinsurance rate credit that grows with the percentage — a higher commitment to insure to value earns a lower rate per $100 of coverage.

• 80% — the most common default; balances premium savings against penalty exposure.
• 90% / 100% — larger rate credits but the insured must carry more limit, and the penalty bites harder if value rises.
• Agreed Value — eliminates penalty risk for an additional premium.

The higher the percentage, the cheaper the rate but the greater the danger that a value increase triggers a penalty at the time of loss.

Coinsurance Outcomes at a Glance

Traps: (1) Coinsurance is tested at the time of loss, not when the policy was written — inflation can push a once-adequate limit below the requirement. (2) The fraction never exceeds 1.0. (3) Agreed Value and total losses suspend the coinsurance calculation.

When Coinsurance Does Not Apply

Coinsurance is suspended in several tested situations: when an Agreed Value option is in force, on a total loss (you simply collect the limit or full value), and on coverages written without a coinsurance clause (many personal lines). It also does not apply once a loss equals or exceeds the policy limit — the limit caps payment regardless of the Did/Should fraction. Recognizing these exceptions prevents you from running the formula when the answer is just "pay the limit."

A Second Worked Example and the Premium Trade-Off

Consider a $1,000,000 building with a 90% clause; required limit is $900,000. The owner carries $720,000 and suffers a $200,000 loss with a $2,500 deductible. Did/Should = 720,000 / 900,000 = 0.80. Payment = 0.80 x 200,000 = 160,000, minus 2,500 = $157,500; the owner eats the $42,500 penalty plus the deductible.

The lesson the exam wants: a higher coinsurance percentage earns a bigger rate credit but raises penalty risk if values inflate. The mechanism is identical to the BPP form (CP 00 10) coinsurance condition in commercial property, so mastering it here pays off twice.

Coinsurance in Commercial vs. Personal Lines

The same Did/Should math appears under different labels across the exam. In commercial property the BPP (CP 00 10) states an explicit coinsurance percentage on the declarations.

In homeowners the identical idea is the 80% replacement-cost condition — carry at least 80% of full replacement cost and partial losses pay replacement cost; carry less and you collect the greater of ACV or the reduced amount. Business income applies coinsurance to 12-month projected income rather than property value. Recognizing that one formula drives all three lets you solve any of them with the single "Did over Should, capped at 1.0, minus deductible" routine.

The #1 Coinsurance Trap: Tested at Time of Loss

The most-missed coinsurance fact is when compliance is judged. The Did/Should fraction uses the property's value at the moment of loss, not when the policy was written. Inflation can quietly push a once-adequate limit below the 80% requirement, creating a penalty on a policy that was compliant at inception.

This is exactly why Inflation Guard and Agreed Value options exist — Inflation Guard nudges the limit upward automatically, while Agreed Value suspends the calculation entirely for the term. When a stem says values rose after the policy was issued, expect a penalty and choose the answer that recomputes against current value.