2.3 Coinsurance and the Coinsurance Formula
Key Takeaways
- Coinsurance penalizes underinsurance: Recovery = (Carried ÷ Required) × Loss − Deductible, with the ratio capped at 1.0.
- Amount Required = coinsurance % × value at the time of loss, not the value at inception.
- Apply the deductible after the coinsurance factor, and cap recovery at the policy limit and the actual loss.
- Meeting or exceeding the required amount yields full recovery; over-insuring gives no bonus.
- Agreed-value endorsements and total losses (and valued-policy laws) remove the coinsurance penalty.
Why Coinsurance Exists
Most property losses are partial, so insureds are tempted to buy a low limit and gamble against a total loss. The coinsurance clause discourages underinsurance by requiring the insured to carry a minimum percentage of the property's replacement (or actual cash) value — commonly 80%, 90%, or 100%. Carry less, and the insured becomes a co-insurer who shares the loss. This is one of the most heavily tested property calculations on the exam.
The Coinsurance Formula
Recovery = (Amount of Insurance Carried ÷ Amount Required) × Loss − Deductible
Where Amount Required = Coinsurance % × Replacement Cost (or ACV) at time of loss. The recovery can never exceed the policy limit or the actual loss.
Worked Example — Penalty Applies
A building has a replacement cost of $500,000 with an 80% coinsurance clause. The insured carries $300,000. A covered fire causes a $100,000 loss (assume no deductible).
- Amount required = 80% × $500,000 = $400,000
- Did/should ratio = $300,000 ÷ $400,000 = 0.75 (75%)
- Recovery = 0.75 × $100,000 = $75,000
The insured absorbs $25,000 as a coinsurance penalty for being underinsured.
Worked Example — No Penalty
Same building, but the insured carries $400,000 (meets the 80% requirement).
- Did/should ratio = $400,000 ÷ $400,000 = 1.0
- Recovery = 1.0 × $100,000 = full $100,000 (no penalty)
When the insured carries at least the required amount, the ratio is capped at 1.0 — there is no "bonus" for over-insuring.
Step-by-Step Method
- Compute Amount Required = coinsurance % × value at time of loss.
- Divide Insurance Carried by Amount Required (cap at 1.0).
- Multiply that ratio by the loss.
- Subtract the deductible.
- Cap the result at the policy limit and the actual loss.
When Coinsurance Does NOT Apply
- Agreed Value endorsement (suspends coinsurance).
- Total losses — the policy limit pays regardless (state valued-policy laws may force the full face amount on real-property total fire losses).
- Most personal-lines homeowners policies (the 80% rule there governs RCV eligibility, not a percentage penalty in the same formula).
Coinsurance Outcomes Table
| Carried | Required (80% of $500K) | Ratio | $100K Loss Recovery |
|---|---|---|---|
| $200,000 | $400,000 | 0.50 | $50,000 |
| $300,000 | $400,000 | 0.75 | $75,000 |
| $400,000 | $400,000 | 1.00 | $100,000 |
| $500,000 | $400,000 | 1.00 (capped) | $100,000 |
Common Traps
- Trap: Use the value at the time of loss, not the limit purchased at inception — inflation can push the required amount higher.
- Trap: Apply the deductible after the coinsurance factor, not before.
- Trap: The penalty never increases recovery; the ratio is capped at 1.0, so over-insuring gains nothing.
- Trap: Coinsurance is a partial-loss concept; on a total loss the limit (or valued-policy law) controls.
Insurance to Value and Why Carriers Require It
Coinsurance is the mechanical enforcement of insurance to value. Because the vast majority of property losses are partial, premiums are calculated on the assumption that most insureds carry close to full value. If a carrier let everyone insure to 50% of value, the rate per $1,000 of coverage would have to nearly double to collect the same total premium for the same expected partial losses. The coinsurance clause keeps rates equitable: insureds who carry to value pay a fair rate and recover in full; insureds who shortcut their limit pay less premium but accept a proportional penalty on partial losses.
Reading the Coinsurance Requirement on the Declarations
The coinsurance percentage appears on the declarations page next to the building coverage. A common commercial setup is 90% coinsurance on the building and business personal property. Always anchor the calculation to the value at the time of loss, because inflation guard or simple cost escalation can raise the required amount above the limit purchased a year earlier — a building insured to value at inception can quietly slip into a penalty position by renewal.
Second Worked Example — Deductible and Cap
A warehouse has a replacement cost of $800,000 at loss with 80% coinsurance. The insured carries $480,000 and suffers a $250,000 loss with a $10,000 deductible.
- Required = 80% × $800,000 = $640,000
- Ratio = $480,000 ÷ $640,000 = 0.75
- Recovery = 0.75 × $250,000 = $187,500, then − $10,000 deductible = $177,500
- Cap check: $177,500 is below the $480,000 limit, so it stands.
The insured eats both the $62,500 coinsurance shortfall and the $10,000 deductible — a vivid illustration of why producers stress insurance to value at every renewal.
Agreed Value as the Coinsurance "Off Switch"
When valuation is difficult or the insured wants certainty, the agreed-value option deletes the coinsurance clause for the policy term in exchange for a signed statement of values and, usually, an appraisal. There is then no did-over-should ratio and no penalty — the policy pays the covered loss up to the limit. Expect at least one exam item that hinges on recognizing agreed value as the way to escape coinsurance math entirely.
A building's replacement cost at the time of loss is $1,000,000 with a 90% coinsurance clause. The insured carries $630,000. A covered $200,000 loss occurs with a $5,000 deductible. What does the insured recover?
An insured meets a 100% agreed-value clause on a $250,000 building. A $40,000 partial loss occurs. How does coinsurance affect the recovery?