2.3 Coinsurance and the Coinsurance Formula
Key Takeaways
- Coinsurance requires the insured to carry a stated percentage of the property's full value (commonly 80%, 90%, or 100%); falling short triggers a penalty on partial losses.
- The coinsurance formula is: (Amount of insurance carried ÷ Amount required) × Loss = Recovery, then subtract the deductible, capped at the policy limit.
- The penalty applies only to partial losses; a total loss pays the policy limit regardless of the coinsurance percentage.
- Did the insured carry enough? The 'required' amount equals the coinsurance percentage times the property's value at the time of loss, not at policy inception.
- Agreed value endorsements waive coinsurance, and a blanket limit with a margin clause can also avoid the penalty across multiple locations.
Why Coinsurance Exists
Most fires and storms cause partial losses, not total losses. If insurers let everyone insure a $500,000 building for only $100,000, owners would underinsure, collect on small losses anyway, and starve the premium pool. The coinsurance clause fixes this by requiring the insured to carry insurance equal to a stated percentage of the property's full value — commonly 80%, 90%, or 100%. Carry enough and you are paid in full (less deductible). Fall short and you become a co-insurer of part of every partial loss.
The Coinsurance Formula
The formula appears on nearly every property exam:
Recovery = (Carried ÷ Required) × Loss − Deductible
Where:
- Carried = the limit of insurance actually purchased.
- Required = coinsurance % × property value at the time of loss.
- Loss = the amount of the covered partial loss.
The result is capped at the policy limit and can never exceed the actual loss. A useful mnemonic: "Did vs. Should" — what you did carry over what you should have carried.
Worked Example 1 — Underinsured
A building is worth $500,000. The policy has an 80% coinsurance clause, so the required amount is 80% × $500,000 = $400,000. The insured carried only $300,000. A fire causes a $100,000 loss; the deductible is $1,000.
- Carried ÷ Required = $300,000 ÷ $400,000 = 0.75
- 0.75 × $100,000 loss = $75,000
- Less deductible $1,000 = $74,000 paid
The insured eats the $25,000 penalty plus the deductible for failing to insure to value.
Worked Example 2 — Adequately Insured
Same $500,000 building, 80% coinsurance (required $400,000), same $100,000 loss and $1,000 deductible — but now the insured carried the full $400,000.
- Carried ÷ Required = $400,000 ÷ $400,000 = 1.00
- 1.00 × $100,000 = $100,000
- Less deductible $1,000 = $99,000 paid
No penalty. Carrying more than required does not increase recovery beyond the actual loss — the ratio is capped at 1.0.
The Critical Total-Loss Rule
Coinsurance penalties apply only to partial losses. If the building is a total loss, the insurer simply pays the policy limit (subject to valuation), regardless of the coinsurance percentage. In Example 1, a total loss of the $500,000 building pays the full $300,000 limit — the underinsured insured is hurt by the low limit, not by an additional coinsurance fraction.
| Scenario (Ex. 1) | Carried $300K, Required $400K | Payment |
|---|---|---|
| $100,000 partial loss | (300/400) × 100,000 − 1,000 | $74,000 |
| $300,000 partial loss | (300/400) × 300,000 − 1,000 = 224,000 | $224,000 |
| Total loss ($500,000) | Pay policy limit | $300,000 |
Avoiding the Penalty
- Agreed value endorsement: the insurer accepts a value and waives coinsurance entirely for the term.
- Blanket coverage with a margin clause: a single limit covers several locations; the margin clause caps recovery at any one location at a percentage of its reported value.
- Inflation guard: automatically increases the limit so insurance-to-value keeps pace with rising rebuilding costs.
Always verify the property's value at the time of loss, not the value when the policy was written — rising construction costs are a common way an insured slips below the coinsurance requirement without realizing it.
Coinsurance vs. Insurance-to-Value Wording
Do not confuse the coinsurance clause (commercial property, an explicit percentage on the Declarations) with the homeowners replacement-cost / insurance-to-value condition. Homeowners forms do not call it coinsurance, but the effect is the same: to collect full replacement cost on a partial loss, the dwelling must be insured to at least 80% of its full replacement cost. Fall below 80% and the insured recovers the greater of ACV or the coinsurance-formula amount — never less than ACV.
The ACV Floor
That ACV floor is a frequent exam wrinkle. Even when an underinsured homeowner triggers the penalty, the policy still pays at least the actual cash value of the partial loss. So the insured receives the larger of (Carried ÷ Required) × full RC of the loss, or the ACV of the loss — protecting against a penalty that would otherwise drop recovery below the depreciated value. Commercial coinsurance has no such ACV floor; the formula result governs directly, subject only to the policy limit.
Coinsurance: Second Worked Example
Reinforce the formula (Carried ÷ Required) × Loss − Deductible, capped at the policy limit. A building is worth $500,000; the policy has an 80% coinsurance clause, so the required amount is $400,000. The insured carries only $300,000. A $100,000 loss occurs with a $1,000 deductible.
Step 1: Required = 80% × $500,000 = $400,000. Step 2: Did/Should = $300,000 ÷ $400,000 = 0.75. Step 3: 0.75 × $100,000 = $75,000. Step 4: subtract the deductible: $75,000 − $1,000 = $74,000 paid. The insured absorbs the rest as a coinsurance penalty for underinsuring.
Why Total Losses Hide the Penalty
A key exam nuance: on a total loss, many states' rules and the policy limit mean the insured collects the full carried limit, so the penalty is invisible — coinsurance penalties bite hardest on partial losses. That is precisely the scenario the exam uses to test whether you understand the clause.
A commercial building is valued at $1,000,000 and is insured for $600,000 under an 80% coinsurance clause. A covered fire causes $200,000 of damage with a $5,000 deductible. How much does the insurer pay?
An insured underinsured a building relative to its 90% coinsurance requirement, then suffered a TOTAL loss. How is the claim settled?