2.3 Coinsurance and the Coinsurance Formula

Why Coinsurance Exists

Most property losses are partial, not total. If insurers let owners buy a small limit and still collect full payment on every fender-and-bumper-sized loss, premiums for everyone would skyrocket. The coinsurance clause ties the premium rate to the insured carrying a limit at or above a stated percentage of the property's full value — typically 80%, 90%, or 100%.

Carry enough and you are paid in full (up to the limit, less deductible). Carry too little and you become a co-insurer of the loss, sharing it proportionally. This is the single most computation-heavy topic on the property exam.

The Formula

(Amount of Insurance Carried ÷ Amount of Insurance Required) × Loss = Recovery

Then subtract the deductible, and never pay more than the policy limit. The "Amount Required" = property value × coinsurance percentage at the time of loss.

Worked Coinsurance Examples

Example 1 — underinsured, 80% clause. A building is worth $500,000. The policy has an 80% coinsurance clause, so the required limit is 0.80 × $500,000 = $400,000. The insured carries only $300,000. A fire causes a $100,000 partial loss with a $1,000 deductible.

Recovery = ($300,000 ÷ $400,000) × $100,000 = 0.75 × $100,000 = $75,000

Less $1,000 deductible = $74,000 paid; insured absorbs $26,000.

The insured carried 75% of what was required, so the carrier pays 75% of the loss.

Example 2 — fully compliant. Same building, but the insured carries the full $400,000. Required = $400,000. ($400,000 ÷ $400,000) × $100,000 = $100,000, less the deductible. No penalty — carrying at least the required amount earns full payment.

Example 3 — 90% clause. Value $1,000,000, 90% coinsurance → required $900,000. Insured carries $720,000; loss is $200,000, $5,000 deductible.

($720,000 ÷ $900,000) × $200,000 = 0.80 × $200,000 = $160,000, less $5,000 = $155,000.

The Total-Loss Exception and Coinsurance Waivers

A crucial exam trap: the coinsurance penalty applies only to partial losses. If the property is a total loss, the insurer pays the full policy limit (subject to valuation), regardless of how short the limit was of the coinsurance requirement. So an underinsured owner is punished on a kitchen fire but not on a burn-to-the-ground total loss — because there is nothing beyond the limit left to share.

Suspending or Avoiding the Penalty

To avoid the penalty, the safest path is insuring to value — buying a limit at or above value × coinsurance percentage and using Inflation Guard so rising replacement costs do not erode compliance over the policy term.

The Coinsurance Formula, Stated and Reordered

Every coinsurance question reduces to the same identity, and the exam expects you to apply it mechanically:

Recovery = (Limit Carried ÷ Limit Required) × Loss − Deductible, capped at the limit and never more than the loss.

The Limit Required equals the coinsurance percentage × the property's value at the time of loss (not the value when the policy was written). Using the value at inception when prices have risen is a common wrong answer; always recompute the requirement on the loss-date value.

Worked Example — 90% Clause With Deductible

A warehouse is worth $1,000,000 at the time of a fire. The policy carries a 90% coinsurance clause and a $250,000 limit, with a $5,000 deductible. The loss is $200,000.

1. Required limit = 0.90 × $1,000,000 = $900,000.
2. Coinsurance factor = $250,000 ÷ $900,000 = 0.2778.
3. Apply to loss = 0.2778 × $200,000 = $55,556.
4. Subtract deductible = $55,556 − $5,000 = $50,556.

The insured, badly underinsured, recovers roughly $50,556 of a $200,000 loss and absorbs the rest as a coinsurance penalty — a vivid illustration of why carrying an adequate limit matters.

Blanket Insurance and the Margin Clause

When one limit covers several locations or several types of property, the policy is written blanket rather than specific. Blanket coverage applies the full limit to whichever location suffers the loss, which protects an insured who misestimated values at any single site. To qualify for blanket rating the insured usually files a Statement of Values (SOV), and insurers may attach a margin clause capping recovery at the SOV value times a stated percentage (e.g., 110%) so blanket coverage does not become a blank check.

The exam contrasts specific (per-item limits, higher penalty risk if any one is short) with blanket (shared limit, lower penalty risk).

The Penalty Is a Sharing of Loss, Not a Cap

A common misread is treating the coinsurance result as a new limit. It is not — it is the insurer's share of the partial loss, after which the deductible is subtracted and the policy limit still caps the payment. The insured effectively becomes a co-insurer for the shortfall and absorbs the uninsured percentage. Remember that the requirement is recomputed on the value at the time of loss, so inflation that raises a building's value during the term can push a previously compliant insured into a penalty.

One More Worked Pass

A retail building is worth $800,000 at loss; an 80% clause sets the required limit at $640,000; the insured carries $480,000; a $120,000 partial loss occurs with a $2,500 deductible. Factor = $480,000 ÷ $640,000 = 0.75. Insurer share = 0.75 × $120,000 = $90,000. Less the deductible = $87,500 paid, capped well under the $480,000 limit. The insured absorbs $32,500 (the 25% coinsurance shortfall) plus the deductible — the recurring lesson that under-insuring is penalized on every partial loss.