2.3 Coinsurance and the Coinsurance Formula
Key Takeaways
- Coinsurance requires the insured to carry coverage equal to a stated percentage of full value, commonly 80%, 90%, or 100%; falling short makes the insured a co-insurer who shares every loss.
- The formula is (Amount Carried / Amount Required) x Loss = Claim, where Amount Required equals property value times the coinsurance percentage.
- The penalty applies to PARTIAL losses, not only total losses, and the payment can never exceed the actual loss or the policy limit.
- Always apply the policy-limit cap after running the formula; forgetting the cap is the most common exam mistake.
- Agreed Value endorsements and inflation-guard provisions are the standard defenses against a coinsurance penalty.
Why Coinsurance Exists
Most property losses are partial, not total. If underinsurance carried no penalty, an owner could insure a $500,000 building for just $100,000, pay a small premium, and still collect most partial losses in full. That would starve the insurer of the premium needed for the real exposure and would be unfair to owners who insure to value.
The coinsurance clause corrects this by requiring the insured to carry coverage equal to a stated coinsurance percentage of the property's value. If they do, losses are paid in full (up to the limit). If they fall short, they become a co-insurer and share in every loss. Common percentages are 80%, 90%, and 100%.
The Coinsurance Formula
Claim Payment = (Amount Carried / Amount Required) x Loss
| Term | Meaning |
|---|---|
| Amount Carried | The policy limit the insured actually purchased |
| Amount Required | Property Value x Coinsurance % |
| Loss | The actual amount of damage |
Two caps always apply: the payment can never exceed the actual loss or the policy limit, whichever is smaller. Any deductible is then subtracted from the result.
Example 1 — Requirement Met
- Building value $500,000; coinsurance 80%; limit carried $400,000; loss $100,000.
- Amount Required = $500,000 x 80% = $400,000.
- Ratio = $400,000 / $400,000 = 100%.
- Claim = 100% x $100,000 = $100,000 — the full loss is paid.
Example 2 — The Penalty
Same building, but the owner carries only $300,000.
- Amount Required = $400,000; Amount Carried = $300,000.
- Ratio = $300,000 / $400,000 = 75%.
- Claim = 75% x $100,000 = $75,000.
The insured absorbs a $25,000 penalty on a $100,000 loss because they self-insured 25% of the exposure. The penalty stings precisely because it hits ordinary partial losses, not only total destruction.
Example 3 — Loss Exceeds the Limit (The Classic Trap)
- Building value $1,000,000; coinsurance 80%; limit carried $700,000; loss $900,000.
- Amount Required = $1,000,000 x 80% = $800,000.
- Ratio = $700,000 / $800,000 = 87.5%.
- Formula result = 87.5% x $900,000 = $787,500.
- But the payment cannot exceed the $700,000 limit, so the insurer pays $700,000.
Students who stop at $787,500 miss the policy-limit cap and choose a wrong answer. Always test the formula result against the limit.
Insurance-to-Value (ITV)
Insurance-to-Value (ITV) is the ratio of insurance carried to property value. Reaching the coinsurance percentage (for example, 80%) means full ITV compliance and no penalty. ITV erodes silently as inflation raises rebuilding costs, which is why a once-adequate limit can fall below the requirement years later.
| ITV carried | Coinsurance required | Outcome on a partial loss |
|---|---|---|
| 80% or more | 80% | Loss paid in full to the limit |
| 60% | 80% | Penalty: pays 60/80 = 75% of loss |
| 40% | 80% | Penalty: pays 40/80 = 50% of loss |
Avoiding the Penalty
- Agreed Value endorsement: waives coinsurance entirely after an appraisal sets the value.
- Inflation-guard endorsement: automatically increases the limit to keep pace with rising costs.
- Annual value reviews: re-rate the limit to current replacement cost each renewal.
Common Exam Traps
- Forgetting the policy-limit cap after running the formula (Example 3).
- Thinking coinsurance applies only to total losses — it applies to every partial loss too.
- Confusing Amount Required with the limit — Amount Required is value times the coinsurance percentage, not the policy limit.
- Applying coinsurance under Agreed Value — Agreed Value suspends the clause, so no penalty is calculated.
A Step-by-Step Method for Any Coinsurance Question
Coinsurance items look intimidating but yield to a fixed routine. Work them in this exact order and you will not miss the limit cap:
- Find Amount Required = property value x coinsurance percentage.
- Identify Amount Carried = the policy limit purchased.
- Compute the ratio = Amount Carried / Amount Required (cap the ratio at 100% — over-insuring never pays a bonus).
- Multiply ratio x loss.
- Apply the policy-limit cap — the payment cannot exceed the limit.
- Subtract the deductible for the net check.
Worked Example — Full Routine With a Deductible
- Building value $600,000; coinsurance 90%; limit carried $486,000; loss $200,000; deductible $5,000.
- Amount Required = $600,000 x 90% = $540,000.
- Ratio = $486,000 / $540,000 = 90%.
- Formula result = 90% x $200,000 = $180,000 (below the $486,000 limit, so no cap).
- Net payment = $180,000 - $5,000 deductible = $175,000.
The insured carried only 81% of value against a 90% requirement, so they self-insured part of the loss and absorbed a coinsurance penalty on top of the deductible.
Coinsurance on Contents and Business Income
Coinsurance is not limited to buildings. Business personal property carries its own coinsurance requirement, and business income coverage uses a coinsurance percentage based on projected annual income (commonly 50%, 60%, 70%, or 80%). The same formula applies: carry less than the required share of the relevant value and the penalty bites every partial loss. On the exam, read carefully which value the coinsurance percentage attaches to — building, contents, or income — because mixing them up produces a wrong Amount Required and a wrong answer.
Why Owners Still Underinsure
Underinsurance is rarely deliberate; it creeps in as construction costs inflate while limits stay flat. A building insured to 80% of value at issue can drift to 60% after a few years of rising labor and material costs. This is exactly the gap that inflation-guard and periodic revaluation are designed to close, and it is why agents are expected to recommend them at each renewal.
Coinsurance Worked Examples ($500K building, 80%, $100K loss)
| Scenario | Amount Required | Amount Carried | Ratio | Claim Paid |
|---|---|---|---|---|
| Insured to value | $400,000 | $400,000 | 100% | $100,000 |
| Underinsured | $400,000 | $300,000 | 75% | $75,000 |
| Severely underinsured | $400,000 | $200,000 | 50% | $50,000 |
| Over-insured (90%) | $400,000 | $450,000 | 100% (capped) | $100,000 |
A building is worth $500,000 with an 80% coinsurance clause. The owner carries $300,000 and suffers a $100,000 loss. Ignoring the deductible, how much does the insurer pay?
A $1,000,000 building has 80% coinsurance and a $700,000 limit. A $900,000 loss occurs. After applying the coinsurance formula, what does the insurer pay?