2.3 Coinsurance and the Coinsurance Formula

Coinsurance: Sharing the Risk of Underinsurance

Coinsurance is a property-policy clause that requires the insured to carry insurance equal to a specified percentage of the property's replacement cost (or ACV) — most commonly 80%, 90%, or 100%. In exchange for the discount that comes with insuring to value, the insured agrees to share in any loss if they are underinsured at the time of loss. Because most claims are partial, insureds are tempted to buy a small limit and still expect full payment on small losses; coinsurance removes that incentive.

The coinsurance clause is the most computation-heavy topic on the national property exam. Expect at least one numeric problem. The formula penalizes only underinsurance — if the insured carries the required amount or more, there is no penalty.

The Coinsurance Formula

Loss Payment = (Did / Should) × Loss − Deductible

Where:

• Did = the limit of insurance the insured actually carried
• Should = coinsurance % × the property's value at the time of loss
• The result is capped at the policy limit and never exceeds the actual loss.

Mnemonic: "Did over Should, times the loss." If Did ≥ Should, the ratio is 1 (or treated as 1 — no penalty), and the insurer pays the loss minus the deductible up to the limit.

Worked Example — Underinsured

A building has a replacement cost of $500,000. The policy has an 80% coinsurance clause, so the required amount (Should) is 80% × $500,000 = $400,000. The insured carried only $300,000 (Did). A fire causes a $100,000 loss; the deductible is $1,000.

1. Required amount = 0.80 × $500,000 = $400,000
2. Coinsurance ratio = Did / Should = $300,000 / $400,000 = 0.75
3. Indemnity before deductible = 0.75 × $100,000 = $75,000
4. Less deductible: $75,000 − $1,000 = $74,000 paid

The insured absorbs $25,000 of the loss as the coinsurance penalty (plus the $1,000 deductible). The penalty exists because they insured to only 60% of value when 80% was required.

Worked Example — Adequately Insured + Traps

Same building ($500,000 RC, 80% coinsurance, $400,000 required). This time the insured carried $450,000 (more than required) and suffers the same $100,000 loss with a $1,000 deductible.

• Did ($450,000) > Should ($400,000), so no penalty. Ratio is treated as 1.
• Payment = $100,000 − $1,000 deductible = $99,000 (within the $450,000 limit).

Common traps:

• Coinsurance is measured by value at the time of loss, not the value when the policy was written — inflation can quietly push an adequately insured building into a penalty.
• The clause applies per the loss calculation, then the policy limit caps the result; on a total loss the insurer never pays more than the limit, regardless of the formula.
• Agreed value endorsements suspend coinsurance entirely.
• The deductible is subtracted after the coinsurance calculation, not before.

Why Coinsurance Exists and How Insurers Apply It

Coinsurance addresses a pricing problem: because most property losses are partial, an insured could buy a small limit and still expect most claims paid in full, leaving the insurer underfunded. The coinsurance clause solves this by rewarding insuring to value — the insured who carries the required percentage pays a lower rate per $100 of coverage, while the underinsured insured shares the loss. The clause therefore aligns premium with exposure across the whole book of business, not just at the individual policy level.

At claim time the adjuster determines the property's value at the time of loss (replacement cost or ACV as the policy specifies), multiplies by the coinsurance percentage to get the required amount (Should), and compares it to the limit carried (Did). The Did/Should ratio is applied to the loss, then the deductible is subtracted, and the result is capped at the policy limit. If Did meets or exceeds Should, the ratio is treated as 1 and no penalty applies.

Coinsurance Variations and Total-Loss Behavior

Several variations recur on the exam. The agreed value option suspends coinsurance for the term in exchange for an appraisal and a signed statement of values — the insured cannot be penalized even if the limit later proves low. An inflation-guard endorsement automatically raises the limit periodically so rising replacement cost does not silently push an adequately insured building below the coinsurance threshold. Some commercial forms substitute a coinsurance waiver for small losses (for example, waiving the calculation when the loss is under a stated dollar figure or 5% of the limit).

A frequently missed point: coinsurance penalties apply to partial losses, but on a total loss the insurer never pays more than the policy limit regardless of the formula — the limit caps recovery. And the penalty is the insured's, not a coverage denial: the insurer pays the proportionate amount, and the insured absorbs the shortfall plus the deductible. State valued-policy laws can override coinsurance on total losses to real property, paying the full face amount.

A Final Worked Sanity Check

To lock in the mechanics, walk one more case slowly. A warehouse has a $2,000,000 replacement cost and a 90% coinsurance clause, so the required limit is $1,800,000. The insured carries $1,350,000 and suffers a $400,000 loss with a $10,000 deductible. The Did/Should ratio is $1,350,000 / $1,800,000 = 0.75. Apply it to the loss: 0.75 × $400,000 = $300,000. Subtract the deductible: $300,000 − $10,000 = $290,000 paid, well within the limit. The insured absorbs the $100,000 coinsurance shortfall plus the deductible — the cost of carrying only 67.5% of value when 90% was required.

Had the insured carried $1,800,000 or more, the ratio would be 1 and the insurer would pay $400,000 − $10,000 = $390,000. The lesson the exam reinforces is that coinsurance is a partial-loss discipline tool: insure to value and the penalty vanishes entirely.