2.3 Coinsurance and the Coinsurance Formula

Why Coinsurance Exists

Most property losses are partial, not total. If insurers let owners buy small limits and still collect full partial-loss payments, those carrying low limits would pay too little premium for the protection they actually receive. Coinsurance is the clause that requires the insured to carry insurance equal to a stated percentage of the property's value, encouraging insurance to value.

Common coinsurance percentages are 80%, 90%, or 100%. Carry at least the required amount and the policy pays partial losses in full (subject to limit and deductible). Carry less and a penalty applies.

The Coinsurance Formula

The formula is sometimes taught as the did-over-should rule:

(Amount of Insurance Carried / Amount of Insurance Required) x Loss = Payment

The amount required equals property value at the time of loss multiplied by the coinsurance percentage. The result is then capped at the policy limit and reduced by the deductible.

Steps:

1. Required = property value x coinsurance %.
2. Ratio = carried / required (never more than 1.0).
3. Payment = ratio x loss, capped at the limit, minus the deductible.

A Worked Penalty Example

A building is worth $500,000 with an 80% coinsurance clause, so the required amount is $400,000. The owner carries only $300,000. A partial fire causes a $100,000 loss with a $1,000 deductible.

• Required = $500,000 x 0.80 = $400,000
• Ratio = $300,000 / $400,000 = 0.75
• Payment = 0.75 x $100,000 = $75,000
• Less deductible = $74,000

The insured eats the $25,000 shortfall as a co-insurer because of underinsurance, plus the deductible.

Time of Loss and Agreed Value

Two points trip up candidates:

• Measured at the time of loss. Compliance is judged using the property's value when the loss occurs, not at policy inception. If property values rise during the term and the limit is not increased, a previously compliant policy can fall short and incur a penalty.
• Total losses ignore the penalty in practice. Because the limit caps payment, a true total loss simply pays the limit; the penalty bites hardest on partial losses.
• Agreed Value suspends coinsurance. When the insured files a statement of values and buys an Agreed Value amount, the insurer waives the coinsurance clause, removing penalty risk for that term.

Coinsurance, the Limit, and Premium Rate

Carrying a higher coinsurance percentage earns a lower rate per $100 of coverage, because the insurer collects premium closer to the property's true exposure. An 80% clause costs more per dollar than a 90% clause, but the 90% insured must carry a larger limit overall.

Pitfall: The formula never pays more than the actual loss or the policy limit. If the carried-to-required ratio computes above 1.0 (the insured is over-insured), cap the ratio at 1.0; the policy still pays only the loss up to the limit. Over-insurance does not produce a bonus payout because indemnity forbids profit.

A Compliant Example for Contrast

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

• Required = $400,000; Carried = $400,000
• Ratio = $400,000 / $400,000 = 1.0
• Payment = 1.0 x $100,000 = $100,000, minus $1,000 = $99,000

By insuring to value, the owner avoids the penalty entirely and collects the full partial loss less only the deductible. This contrast is the heart of most coinsurance questions.

Common Coinsurance Traps

Four mistakes recur on the exam, and recognizing them is worth several questions:

• Applying the penalty to a total loss. A total loss simply pays the limit; the penalty is a partial-loss mechanism. Do not multiply a total loss by the coinsurance ratio.
• Using the limit instead of the loss as the final step. Compute the penalty payment first, then cap it at the limit, then subtract the deductible.
• Measuring value at inception. Always use property value at the time of loss.
• Forgetting the deductible. After the ratio is applied, the deductible still comes off the penalized amount.

Insurance to Value Is the Goal

Coinsurance is ultimately a tool to push owners toward insurance to value, the practice of carrying limits that match the true replacement exposure. Because most fires and storms damage only part of a building, an owner tempted to insure a $1,000,000 building for only $300,000 would otherwise pay a fraction of the fair premium yet still collect on the common partial loss.

The coinsurance penalty corrects that imbalance by making the underinsured owner a co-insurer of every partial loss in proportion to the shortfall. Agreed Value, inflation-guard endorsements, and periodic appraisals are the practical tools agents use to keep clients compliant as values rise.

Reading a Coinsurance Question Quickly

When a question gives you a value, a coinsurance percentage, a carried limit, a loss, and a deductible, work the steps in fixed order:

The owner here recovers $87,500 of a $120,000 loss because the $480,000 limit fell short of the $640,000 requirement, leaving the insured to absorb the rest.