2.3 Coinsurance and the Coinsurance Formula
Key Takeaways
- Coinsurance forces insurance to value by penalizing underinsurance on every partial loss.
- Formula: (Did Carry / Should Carry) x Loss, then subtract the deductible; Should Carry = value x coinsurance %.
- Value is measured at the time of loss, and the result is capped at the policy limit.
- Coinsurance does not penalize total losses, and an Agreed Value endorsement suspends the clause.
Why Coinsurance Exists
Most property losses are partial, not total. If underinsurance carried no penalty, an owner could insure a $500,000 building for $100,000, pay a fraction of the premium, and still collect most partial losses — starving the insurer of premium for the real exposure. The coinsurance clause corrects this by penalizing underinsurance on every loss, pushing owners to insure to value.
The clause states a required percentage of the property's value that must be carried — typically 80%, 90%, or 100%. Carry at least that percentage and losses are paid in full up to the limit (less deductible). Carry less and the insured becomes a coinsurer, sharing every partial loss proportionally.
Did / Should x Loss
The formula every P&C exam tests:
Payment = (Did Carry / Should Carry) x Loss - Deductible
where Should Carry = Property Value x Coinsurance %. The payment can never exceed the policy limit.
| Term | Meaning |
|---|---|
| Did Carry | The limit of insurance actually purchased |
| Should Carry | Value at time of loss x coinsurance percentage |
| Loss | Amount of the covered partial loss |
Worked example. Building value $400,000; 80% coinsurance, so Should Carry = $320,000. The insured bought only $240,000 (Did Carry). A fire causes a $100,000 loss; deductible $1,000.
(240,000 / 320,000) x 100,000 = 0.75 x 100,000 = $75,000
$75,000 - $1,000 deductible = $74,000 paid
The insured eats the $25,000 coinsurance penalty plus the deductible because they were underinsured.
Test Traps on Coinsurance
Several predictable trick patterns appear:
- Penalty applies only to partial losses. On a total loss, the most payable is the policy limit anyway, so the formula is moot — the insured simply collects the limit (less deductible).
- Apply the formula before subtracting the deductible, not after. Reversing the order is the classic wrong answer.
- Value is measured at the time of loss, not when the policy was written — inflation can push a once-compliant insured into a penalty.
- Agreed Value endorsement suspends coinsurance. The insurer accepts a stated value and waives the penalty entirely; questions test that you know this turns the clause off.
- If the formula result exceeds the limit, cap it at the limit. The math result is a ceiling, not a guarantee above the limit.
A quick reasonableness check: if the insured carried more than required, the Did/Should ratio is >1, but you cap it at 1.0 — there is never a bonus for over-insuring.
A building is valued at $600,000 with an 80% coinsurance clause. The owner carries $360,000. A covered partial loss of $90,000 occurs with a $2,500 deductible. How much does the insurer pay?
An insured fully meets the 80% coinsurance requirement, then suffers a total loss equal to the property value. How is the claim settled?
The Coinsurance Formula and a Full Worked Example
Coinsurance exists to make insureds carry insurance close to full value rather than gambling that losses will be small. The clause requires the insured to carry at least a stated percentage (commonly 80, 90, or 100 percent) of the property's value at the time of loss. The settlement formula is: (amount of insurance carried divided by amount required) times the loss, then minus the deductible, capped at the policy limit. Required equals the coinsurance percentage times the property value at loss. The result is the most-tested numeric in property insurance.
Step by Step on a Penalized Claim
Take a building worth 500,000 dollars with an 80 percent coinsurance clause, so the insured must carry 400,000 dollars. If the insured carries only 300,000 dollars and suffers a 100,000-dollar partial loss with a 2,500-dollar deductible, compute 300,000 / 400,000 = 0.75. Multiply 0.75 times 100,000 = 75,000, then subtract the 2,500 deductible to pay 72,500 dollars. The insured absorbs the 25,000-dollar coinsurance penalty plus the deductible as a self-imposed cost of underinsurance. The penalty disappears only when the insured carries the full required amount.
Why Total Losses Behave Differently
Coinsurance penalizes partial losses but not most total losses, because on a total loss the policy simply pays its limit (or, in valued-policy states, the face amount), and the limit is already less than the property value if the insured was underinsured. This is why some underinsured owners feel protected after a fire that destroys everything yet are shocked after a hailstorm that damages only the roof; the partial loss triggers the proportional penalty while a total loss would have paid the full, if inadequate, limit. The exam frequently contrasts these two outcomes.
Agreed Value and Coinsurance Traps
To avoid coinsurance disputes, commercial insureds elect the Agreed Value option, filing a signed statement of values; the insurer then suspends the coinsurance condition for the term, paying the proportion the limit bears to the agreed value. Common exam traps include using the property's original cost instead of value at the time of loss, forgetting to subtract the deductible after applying the proportion, and applying coinsurance to a total loss where it does not bite. Always identify the value at the time of loss first, then the required amount, then the proportion, then the deductible.
Coinsurance vs. a Flat Limit: The Conceptual Point
Coinsurance is not a penalty for honest mistakes alone; it is the pricing bargain that lets insureds who carry adequate limits pay rates predicated on full-value insurance. An insured who deliberately under-insures pays less premium but accepts the proportional reduction on partial losses.
A frequent exam comparison contrasts a policy with no coinsurance clause (which pays the loss up to the limit regardless of insurance-to-value) against a coinsurance policy. The takeaway is that removing coinsurance, as the BOP does, shifts the insurer's risk and is reflected in the rate, while coinsurance keeps rates lower for insureds who insure to value.