2.3 Coinsurance and the Coinsurance Formula
Key Takeaways
- Coinsurance requires the insured to carry coverage equal to a stated percentage of property value, commonly 80%, 90%, or 100%.
- The formula is (Amount Carried / Amount Required) x Loss, where Amount Required equals Property Value times the coinsurance percentage.
- The penalty applies to PARTIAL losses, not only total losses, and payment can never exceed the lesser of the actual loss or the policy limit.
- The deductible is subtracted AFTER the coinsurance calculation, and over-insuring earns no bonus (ratio caps at 100%).
- Agreed Value, inflation-guard endorsements, and annual value reviews are the practical defenses against a coinsurance penalty.
Why the Coinsurance Clause Exists
Most property losses are partial, not total. If underinsurance carried no penalty, an owner would insure a $500,000 building for $100,000, pay a small premium, and still recover most partial losses, starving the insurer of premium for the real exposure. The coinsurance clause corrects this by penalizing underinsurance on every loss, which pushes owners to insure to value.
Common coinsurance percentages are 80% (most common), 90%, and 100%. The percentage is shown on the Declarations next to each item of coverage.
The Coinsurance Formula
The formula appears on nearly every property exam:
Claim Payment = (Amount Carried / Amount Required) x Loss
| Term | Meaning |
|---|---|
| Amount Carried | The policy limit actually purchased |
| Amount Required | Property Value times the coinsurance percentage |
| Loss | The actual amount of damage |
Two caps always apply: payment can never exceed the actual loss or the policy limit, whichever is less. The deductible is subtracted from the result. And the ratio caps at 100%, because over-insuring earns no bonus.
Three Worked Examples
Example 1 - Requirement Met. Building value $500,000; coinsurance 80%; limit $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 - Penalty. Same building, but only $300,000 carried. Required = $400,000; Ratio = $300,000 / $400,000 = 75%. Claim = 75% x $100,000 = $75,000. The insured absorbs a $25,000 coinsurance penalty.
Example 3 - Loss Exceeds the Limit. Value $1,000,000; coinsurance 80%; limit $700,000; loss $900,000. Required = $800,000. Ratio = $700,000 / $800,000 = 87.5%. Formula result = 87.5% x $900,000 = $787,500, but the policy limit caps payment at $700,000. This is the most common trap: candidates apply the formula and forget the limit cap.
Where the Deductible Enters, and How to Avoid the Penalty
Fully worked with a deductible: value $500,000; coinsurance 80% (required $400,000); carried $360,000; loss $50,000; deductible $1,000. Ratio = $360,000 / $400,000 = 90%. Formula = 90% x $50,000 = $45,000. That is below both the loss and the limit, so subtract the deductible: $45,000 minus $1,000 = $44,000 paid.
| Defense | How it helps | Caveat |
|---|---|---|
| Carry adequate limits | Insure to at least the required percentage | Values drift; review annually |
| Agreed Value clause | Suspends coinsurance entirely | Needs appraisal and statement of values |
| Inflation-guard endorsement | Auto-increases limits 4-8% per year | Does not guarantee compliance |
Remember the order of operations: compute Amount Required, form the ratio (cap at 100%), apply it to the loss, take the lesser of the result, the loss, or the limit, then subtract the deductible.
Insurance to Value (ITV) and the 80% Standard
Underlying coinsurance is the concept of insurance to value (ITV), the ratio of insurance carried to property value.
ITV Ratio = Amount of Insurance / Property Value
| ITV ratio | Status | Consequence |
|---|---|---|
| 100% or more | Fully insured | Full loss recovery |
| 80-99% | Meets a typical 80% clause | No penalty |
| Below 80% | Underinsured | Coinsurance penalty applies |
A frequent reasoning question asks why insurers require 80% rather than 100%. The answer is that most losses are partial, so requiring 80% gives the insurer adequate premium relative to true exposure while building in a margin for ordinary fluctuations in value. Setting the bar at 100% would penalize honest insureds for minor inflation between renewals. The 80% standard balances fair pricing against ease of compliance, which is exactly the policy rationale the exam wants you to recognize.
Worked ITV: $400,000 of coverage on a $500,000 building gives ITV = $400,000 / $500,000 = 80%, exactly meeting an 80% requirement, so no penalty applies even on a partial loss.
Coinsurance on Business Income, and the Five Exam Points
Coinsurance is not limited to buildings. Business income coverage applies a coinsurance percentage (commonly 50%, 60%, 70%, or 80%) to the 12-month net income plus continuing expenses the business would have earned had no loss occurred. Select a 50% business-income coinsurance percentage and the insured must carry a limit equal to at least half of that projected figure, or the same proportional penalty hits a business-interruption claim.
The business income worksheet supports the figure, and an agreed value option (or the monthly limit of indemnity and maximum period of indemnity options) sidesteps the coinsurance test on time-element coverage.
Five points settle most coinsurance questions:
- Coinsurance bites on partial losses, not only total losses.
- Payment is the lesser of the formula result, the actual loss, or the policy limit.
- 80% is the most common requirement, and the deductible comes off after the coinsurance math.
- Agreed Value is the clean way to eliminate the penalty.
- The shortfall is borne by the insured, who becomes a co-insurer for the uninsured portion.
A building is worth $800,000 with an 80% coinsurance clause. The owner carries $480,000 and suffers a $200,000 partial loss (ignore the deductible). What does the insurer pay?
A $1,000,000 building has 80% coinsurance and a $700,000 policy limit. A $900,000 loss occurs and the owner met the coinsurance requirement. How much does the insurer pay?
A Five-Step Solution Method for Any Coinsurance Question
To avoid the common traps, apply the same ordered procedure to every coinsurance problem on the exam. Working the steps in this exact order prevents the limit-cap and deductible mistakes.
| Step | Action |
|---|---|
| 1 | Compute Amount Required = Property Value x coinsurance % |
| 2 | Form the ratio = Amount Carried / Amount Required (cap at 100%) |
| 3 | Multiply the ratio by the Loss |
| 4 | Take the lesser of that result, the actual loss, or the policy limit |
| 5 | Subtract the deductible to get the final payment |
Worked drill: value $600,000, 90% coinsurance, limit $500,000, loss $120,000, deductible $2,500. Step 1: required = $540,000. Step 2: ratio = $500,000 / $540,000 = 92.6%. Step 3: 0.926 x $120,000 = $111,120. Step 4: lesser of $111,120, $120,000, $500,000 = $111,120. Step 5: minus $2,500 = $108,620 paid.
Exam Trap: Students routinely forget Step 2's 100% cap when the insured over-insures - carrying more than required never pays a bonus, so the ratio is held at 1.0 and the loss is paid in full (up to the limit, less deductible).