2.3 Coinsurance and the Coinsurance Formula
Key Takeaways
- Coinsurance requires carrying a stated percentage (commonly 80/90/100%) of value; falling short makes the insured a co-insurer on every loss.
- Formula: (Amount Carried / Amount Required) x Loss, where Amount Required = Value x Coinsurance %.
- The penalty applies to partial losses; payment never exceeds the actual loss or the policy limit, then the deductible is subtracted.
- The classic trap: apply the ratio, get a number above the limit, and forget to cap at the policy limit.
- Agreed Value (CP 12 30) and Inflation Guard are the practical defenses against a coinsurance penalty.
Why Coinsurance Exists
Most property losses are partial, not total. Without a penalty for underinsurance, an owner would insure a $500,000 building for only $100,000, pay a small premium, and still recover nearly all partial losses — leaving the insurer underfunded for the true exposure. The coinsurance clause corrects this by requiring the insured to carry coverage equal to a stated percentage of the property's value (the coinsurance percentage). If the insured carries less, they become a co-insurer and share in every loss.
Common coinsurance percentages on commercial property are 80%, 90%, and 100%. A higher percentage earns a lower rate, because higher insurance-to-value spreads premium more fairly.
The Coinsurance Formula
Claim Payment = (Amount Carried / Amount Required) x Loss
| Term | Meaning |
|---|---|
| Amount Carried | The policy limit actually purchased |
| Amount Required | Property Value × Coinsurance % |
| Loss | The actual amount of damage |
Memory aid candidates use: "Did / Should × Loss." Two caps always apply afterward: the payment can never exceed the actual loss or the policy limit, whichever is less. The deductible is then subtracted from the formula result. If the insured met or exceeded the requirement, the ratio is capped at 100% — there is no bonus for over-insuring.
Three Worked Examples
Example 1 — Requirement met. Building value $500,000; coinsurance 80%; limit $400,000; loss $100,000.
- Amount Required = $500,000 × 80% = $400,000.
- Ratio = $400,000 ÷ $400,000 = 100%.
- Claim = 100% × $100,000 = $100,000 — full loss paid (less deductible).
Example 2 — Penalty. Same building, owner carries only $300,000.
- Amount Required = $400,000; Carried = $300,000.
- Ratio = $300,000 ÷ $400,000 = 75%.
- Claim = 75% × $100,000 = $75,000. The insured absorbs a $25,000 penalty.
Example 3 — Loss exceeds the limit (the classic trap). Value $1,000,000; coinsurance 80%; limit $700,000; loss $900,000.
- Required = $1,000,000 × 80% = $800,000.
- Ratio = $700,000 ÷ $800,000 = 87.5%.
- Formula = 87.5% × $900,000 = $787,500, but capped at the $700,000 policy limit — insurer pays $700,000.
Avoiding the Penalty: Agreed Value, Inflation Guard, ITV
Insurance-to-Value (ITV) = Amount of Insurance ÷ Property Value. Reaching the coinsurance percentage avoids the penalty entirely.
| Method | How it helps | Caveat |
|---|---|---|
| Carry adequate limits | Insure to at least the required % | Values drift; review annually |
| Agreed Value (CP 12 30) | Suspends the coinsurance clause for the policy term | Requires a signed Statement of Values; must be renewed |
| Inflation Guard | Automatically raises the limit through the term | Estimated rate may lag real inflation |
Coinsurance vs. coordination of benefits: on the exam, "coinsurance" in property means the insurance-to-value penalty above. In health insurance, coinsurance means the insured's percentage share of covered costs after the deductible — do not confuse the two.
Coinsurance on Personal Lines and the 80% Rule
Homeowners forms apply the same logic through the building loss-settlement condition: insure the dwelling to at least 80% of replacement cost to settle building losses on a full replacement-cost basis. Carry less than 80% and the insurer pays the greater of the ACV of the damaged part or the formula amount (carried / (0.80 × RC value)) × loss.
Worked personal-lines example. A home costs $400,000 to rebuild. The owner insures it for $280,000 (only 70% of RC). A kitchen fire causes $40,000 of damage.
- Required = $400,000 × 80% = $320,000.
- Ratio = $280,000 ÷ $320,000 = 87.5%.
- Formula payment = 87.5% × $40,000 = $35,000 (the insured eats $5,000), assuming that exceeds the ACV alternative.
This is why agents push inflation guard and periodic replacement-cost re-estimates: construction inflation silently pushes the home below the 80% threshold between renewals.
Coinsurance on Business Income and Blanket Limits
Coinsurance also appears outside direct property. On business income, the coinsurance percentage (often 50%, 60%, 70%, 80%, etc.) is applied to the 12-month income the business would have earned, not to building value — so the basis of the calculation changes even though the penalty math is identical.
A blanket limit covers multiple buildings or locations under one limit. To qualify, the insured signs a Statement of Values; coinsurance is then applied to the total values of all covered property. Underreporting on the statement triggers a margin clause or coinsurance penalty across the blanket, so accurate values matter even more than on a single-location specific limit.
A Step-by-Step Penalty Worked Example
Apply the formula (Did ÷ Should) × Loss − Deductible = Payment, capped at the limit. Suppose a building worth $500,000 carries an 80% coinsurance clause, so the insured should carry $400,000. The insured actually carries only $300,000 and suffers a $100,000 loss with a $1,000 deductible.
- Ratio: $300,000 ÷ $400,000 = 0.75
- Apply to loss: 0.75 × $100,000 = $75,000
- Subtract deductible: $75,000 − $1,000 = $74,000 paid; the insured absorbs the $26,000 penalty for underinsuring.
Had the insured carried the full $400,000, the ratio would be 1.0 and the insurer would pay $99,000.
A commercial building is valued at $600,000 with an 80% coinsurance clause. The insured carries $360,000. A fire causes $120,000 in damage; the deductible is $1,000. What does the insurer pay?
Which endorsement suspends the coinsurance clause for the policy term in exchange for the insured filing a signed Statement of Values?