2.3 Coinsurance and the Coinsurance Formula
Key Takeaways
- Coinsurance requires the insured to carry a limit equal to a stated percentage (commonly 80%, 90%, or 100%) of the property's value, or share in partial losses as a penalty.
- The coinsurance formula is (Did Carry / Should Carry) x Loss, then subtract the deductible — the result is capped at the policy limit.
- Coinsurance penalties apply only to partial losses; a total loss simply pays the policy limit.
- Underinsurance triggers the penalty; insuring to value (or adding an agreed-value option) avoids it.
- Value is measured at the time of loss, so rising replacement costs and inflation can quietly push an insured below the coinsurance threshold.
What Coinsurance Is
Most property losses are partial, not total. If insureds could buy a small limit and still collect fully on every small loss, those who insure to full value would subsidize those who underinsure. Coinsurance corrects this by requiring the insured to carry a limit equal to a stated percentage of the property's value. Meet the percentage and partial losses are paid in full (less the deductible); fall short and the insured becomes a co-insurer for the shortfall.
The coinsurance percentage is shown on the Declarations and is commonly 80%, 90%, or 100%.
The Coinsurance Formula
The formula every P&C exam tests:
Payment = (Did Carry / Should Carry) x Loss - Deductible
Where:
- Did Carry = the limit actually purchased.
- Should Carry = property value at the time of loss x coinsurance percentage.
- The result is then capped at the policy limit.
Worked Example — Underinsured
A building is worth $500,000. The policy carries an 80% coinsurance clause, so the insured should carry $500,000 x 80% = $400,000. The insured actually bought only $300,000 of coverage. A fire causes a $100,000 partial loss; the deductible is $1,000.
Payment = ($300,000 / $400,000) x $100,000 - $1,000
Payment = 0.75 x $100,000 - $1,000
Payment = $75,000 - $1,000 = $74,000
The insured carried only 75% of the required amount, so the insurer pays 75% of the loss. The $25,000 coinsurance penalty plus the $1,000 deductible falls on the insured.
Worked Example — Properly Insured
Same building, same 80% clause, but the insured carried the full $400,000.
Did Carry / Should Carry = $400,000 / $400,000 = 1.00
Payment = 1.00 x $100,000 - $1,000 = $99,000
Because the insured met the requirement, the partial loss is paid in full less the deductible. Carrying more than the requirement does not increase the payout beyond the loss; the ratio is capped at 1.00.
The Two Rules That Trip Students
| Rule | Effect |
|---|---|
| Penalty applies only to partial losses | A total loss simply pays the policy limit; the formula never reduces below the limit on a total loss |
| Ratio is capped at 1.00 | Over-insuring relative to the requirement does not pay more than the actual loss |
Total-loss illustration: If the same $500,000 building with $300,000 of coverage is completely destroyed, the insurer pays the $300,000 limit (less deductible) — not a coinsurance-reduced figure. The penalty exists to police partial losses, where underinsured insureds would otherwise escape consequences.
Why Underinsurance Happens — Inflation
Value is measured at the time of loss, not at policy inception. If construction costs rise 8% a year and the insured never raises the limit, a building insured exactly to 80% two years ago may now sit well below the threshold and face a penalty on the next claim. This is why insurers offer:
- Inflation guard endorsements that automatically raise the limit.
- Agreed value options that suspend coinsurance entirely once the insurer accepts a statement of values, eliminating the penalty risk.
Order of Operations
When a question stacks valuation, coinsurance, and a deductible, work in this order: (1) determine the loss amount on the correct valuation basis (ACV or RC); (2) apply the coinsurance ratio; (3) subtract the deductible; (4) cap at the policy limit. Skipping straight to subtracting the deductible is the most common arithmetic error on these problems.
Coinsurance on a Replacement-Cost Basis
Coinsurance and valuation interact, and the exam likes to combine them. The "should carry" amount is measured on the same valuation basis the policy uses. On a replacement-cost policy the requirement is a percentage of the building's full replacement cost, not its depreciated ACV. Because replacement cost is larger than ACV, the dollar amount the insured must carry is also larger — a building that looks adequately insured at ACV can fall short of an RC-based coinsurance requirement.
Worked example: A building has a replacement cost of $1,000,000 and an 80% RC coinsurance clause, so the insured should carry $800,000. The insured bought $600,000. A $200,000 partial loss occurs.
Payment = ($600,000 / $800,000) x $200,000 = 0.75 x $200,000 = $150,000
The insured recovers 75% of the loss and absorbs the remaining $50,000 as the coinsurance penalty.
Reporting Forms and Coinsurance
For businesses whose inventory values swing widely (warehouses, seasonal retailers), insurers use value reporting forms. The insured periodically reports current values, the premium adjusts, and the full-reporting clause acts like coinsurance: if the insured under-reports values at the last report before a loss, recovery is reduced by the same proportion. Honest, current reporting protects the insured exactly the way insuring-to-value does under a standard coinsurance clause.
Common Coinsurance Traps
| Trap | Correct handling |
|---|---|
| Using the loss as the "should carry" base | "Should carry" = property value x coinsurance %, never the loss |
| Applying the penalty to a total loss | Total losses pay the limit; the formula is for partial losses |
| Mixing valuation bases | Measure "should carry" on the same basis (ACV or RC) the policy uses |
| Forgetting the 1.00 cap | Over-insuring never pays more than the actual loss |
A building worth $500,000 carries an 80% coinsurance clause. The insured purchased $300,000 of coverage and suffers a $100,000 partial loss with a $1,000 deductible. What does the insurer pay?
An insured underinsures a building subject to an 80% coinsurance clause, then the building is a TOTAL loss. How does coinsurance affect the settlement?