2.3 Coinsurance and the Coinsurance Formula

Insurance to Value

Insurers price property coverage assuming most losses are partial, not total. Statistically, large buildings rarely burn to the ground; the vast majority of claims damage only a fraction of the structure. To keep premiums fair, the coinsurance clause requires the insured to carry a limit equal to a stated percentage (commonly 80%, but also 90% or 100%) of the property's full value.

Carry enough, and partial losses are paid in full (less deductible). Carry too little, and the insured becomes a co-insurer and shares part of every loss as a penalty proportional to how far short of the required amount the limit falls.

The Coinsurance Formula

The formula is the single most-tested calculation on the property portion:

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

Where Limit Required = Property Value × Coinsurance %. The payment can never exceed the policy limit, and you stop at the limit even if the formula produces a larger number ('Did I Apply, Limit?' — Divide, Apply to loss, cap at Limit).

Worked Example (Underinsured)

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

• Step 1 — Required: $500,000 × 0.80 = $400,000.
• Step 2 — Ratio: $300,000 ÷ $400,000 = 0.75 (the 'did' over 'should have').
• Step 3 — Apply: 0.75 × $100,000 = $75,000.
• Step 4 — Deductible: $75,000 − $1,000 = $74,000 paid.

The insured eats $26,000 — the $25,000 coinsurance penalty plus the $1,000 deductible — because they were underinsured.

A Fully-Insured Comparison

Return to the $500,000 building, but now the owner carries the required $400,000 (exactly 80%). The same $100,000 loss with a $1,000 deductible is settled as: ratio = $400,000 ÷ $400,000 = 1.00, so 1.00 × $100,000 = $100,000, minus the $1,000 deductible = $99,000 paid. No penalty.

The lesson is stark: the underinsured owner in the prior example collected $74,000 on the identical loss, while the properly insured owner collected $99,000 — a $25,000 swing produced entirely by carrying enough coverage. Always determine the required limit first, then compare it to the carried limit before doing anything else.

When the Penalty Disappears

Key rules: if the carried limit meets or exceeds the required amount, ignore the formula and pay the loss in full up to the limit. On a total loss, the coinsurance formula does not apply — the insurer simply pays up to the limit carried (subject to state valued-policy laws). Agreed Value also suspends coinsurance.

Why Insurers Use Coinsurance

Without a coinsurance clause, owners would rationally insure only to the size of a likely partial loss — say 20% of value — and pay a tiny premium, leaving the insurer underfunded across its whole book. Coinsurance corrects this by rewarding insurance to value with a lower rate per $100 of coverage and penalizing underinsurance at claim time.

The owner who insures to the required percentage pays more total premium but a cheaper rate, and collects partial losses in full. The owner who skimps pays a low premium but absorbs a penalty on every partial loss.

A related concept, the agreed value option (or coinsurance waiver), lets the insured submit a signed statement of values. In exchange the insurer suspends the coinsurance clause for the policy term, removing penalty risk entirely until the option expires and must be renewed.

Exam Traps

• The ratio is 'did over should' — Limit Carried over Limit Required. Flipping it is the most common error.
• Apply the coinsurance penalty before subtracting the deductible.
• Coinsurance is measured at the time of loss, using the property's value then, not when the policy was written.
• More insurance to value lowers the rate per $100, so insuring to value is cheaper per dollar of coverage, not just penalty-free.
• The agreed value option suspends coinsurance for the term; do not apply the formula when it is in effect.

A Second Coinsurance Computation and the Penalty Logic

Coinsurance exists to make insureds carry limits proportional to value, spreading premium fairly. The formula is:

(Did Carry / Should Have Carried) x Loss - Deductible = Payment (never exceeding the policy limit).

Worked example: A building worth $500,000 carries an 80% coinsurance clause, so the insured should carry $400,000. The insured actually carries $300,000 and suffers a $100,000 loss with a $1,000 deductible.

The insured absorbs the $26,000 shortfall as a coinsurance penalty for underinsuring.

Exam trap: Coinsurance is measured at the time of loss, using the property's value then - not the value when the policy was written. If the insured meets or exceeds the required percentage, there is no penalty and the loss is paid in full up to the limit. Agreed value endorsements suspend coinsurance entirely, which is why high-value commercial accounts use them.