2.3 Coinsurance and the Coinsurance Formula
Key Takeaways
- Coinsurance formula: (Limit Carried ÷ Limit Required) × Loss − Deductible, where Limit Required = Value × Coinsurance %.
- Underinsuring triggers a penalty on partial losses; the insured shares the loss in proportion to the shortfall.
- Carrying exactly or above the required amount caps the ratio at 1.0, so over-insuring buys no extra recovery.
- An agreed value provision suspends coinsurance for the policy term.
- Total losses still cap at the policy limit, so severe underinsurance hurts most on a total loss.
Why Coinsurance Exists
Most property losses are partial, not total. If insurers let policyholders buy low limits and still collect full partial losses, premiums would be inadequate and unfair to those who insure fully. The coinsurance clause solves this by requiring the insured to carry coverage equal to a stated percentage of the property's value, commonly 80%, 90%, or 100%. Insureds who comply are paid in full (up to the limit); those who underinsure share, or coinsure, part of every partial loss.
This is the most computation-heavy topic on the national exam, so master the formula until it is automatic.
The Coinsurance Formula
Payment = (Limit Carried ÷ Limit Required) × Loss − Deductible
Where Limit Required = Property Value × Coinsurance %. The result is capped at the policy limit and at the actual loss. A simple memory device is "Did ÷ Should × Loss" — what you did carry over what you should have carried.
Steps:
- Find the amount required (value × coinsurance %).
- Divide the limit actually carried by the amount required.
- Multiply that ratio by the loss.
- Subtract the deductible; never exceed the policy limit.
Worked Example: Underinsured
A building is worth $1,000,000 with an 80% coinsurance clause. The owner carries $600,000 and suffers a $250,000 loss; the deductible is $5,000.
- Amount required: $1,000,000 × 80% = $800,000
- Ratio: $600,000 ÷ $800,000 = 0.75 (75%)
- Indemnity: 0.75 × $250,000 = $187,500
- Less deductible: $187,500 − $5,000 = $182,500 paid
The owner absorbs the remaining $62,500 of the loss as the coinsurance penalty for carrying only 75% of what the clause required.
Worked Example: Compliant and Over-Insured
Using the same $1,000,000 building and 80% clause, suppose the owner carries $800,000 (exactly the requirement) and suffers a $250,000 loss with a $5,000 deductible.
- Ratio: $800,000 ÷ $800,000 = 1.0 (100%) — no penalty
- Payment: $250,000 − $5,000 = $245,000
Carrying more than required (say $900,000) does not increase recovery beyond the actual loss; the ratio simply caps at 1.0. Over-insuring wastes premium and violates indemnity, so it earns nothing extra.
Alternatives and Exam Traps
- An agreed value option suspends coinsurance: the insurer and insured agree on a value at inception, and the clause is waived for the term.
- A stated amount endorsement is similar but applies mostly to mobile equipment and autos.
- Total losses ignore the penalty only up to the policy limit — a severely underinsured total loss still pays only the limit, which may be far below value.
| Coverage Carried (on $1M, 80% req.) | Ratio | $250k Loss Payment (pre-deductible) |
|---|---|---|
| $400,000 | 0.50 | $125,000 |
| $600,000 | 0.75 | $187,500 |
| $800,000 | 1.00 | $250,000 (full) |
A warehouse valued at $500,000 carries an 80% coinsurance clause. The owner insures it for $300,000 and suffers a $100,000 partial loss with a $2,000 deductible. How much does the insurer pay?
Which option allows an insured to avoid the coinsurance penalty entirely for the policy term?
Insurance to Value and Inflation Guard
Coinsurance pressures insureds toward insurance to value (ITV), carrying limits close to the full replacement cost. Because rebuilding costs rise, ISO offers an inflation guard endorsement that automatically increases limits by a stated percentage during the term, helping the insured stay compliant. On Homeowners forms, a 100% replacement-cost requirement plus inflation guard works much like coinsurance to keep coverage adequate.
Blanket Insurance and the Coinsurance Penalty Trap
With blanket coverage (one limit over several buildings or buildings plus contents), coinsurance is applied to the combined value of all items using a statement of values filed at inception. This often lets an insured comply more easily than specific limits at each location, because values can shift between sites without triggering a penalty.
The classic exam trap is forgetting that coinsurance applies on partial losses. On a total loss the policy simply pays the lesser of the limit or the loss — the penalty cannot push payment below what a proportional partial loss would have produced, but it also cannot raise payment above the carried limit. Always confirm whether the loss is partial before running the formula.
A Larger Underinsurance Example
Work one more to cement the formula. A retail building is valued at $2,000,000 with a 90% coinsurance clause. The owner carries $1,350,000 and suffers a $400,000 partial loss; the deductible is $10,000.
- Amount required: $2,000,000 × 90% = $1,800,000
- Ratio: $1,350,000 ÷ $1,800,000 = 0.75 (75%)
- Indemnity: 0.75 × $400,000 = $300,000
- Less deductible: $300,000 − $10,000 = $290,000 paid
The owner carried only 75% of the required limit, so the insurer pays 75% of the loss before the deductible, and the owner absorbs the $100,000 coinsurance shortfall plus the deductible. Recognizing that the penalty scales with the shortfall ratio lets you answer any variation quickly.
Coinsurance vs. Insurance to Value on Personal Lines
Commercial property forms state coinsurance as an explicit percentage selected on the declarations (80/90/100%). Homeowners policies usually do not print the word coinsurance; instead they impose an insurance-to-value requirement, typically 80% of replacement cost, as a precondition to settling building losses on a replacement-cost basis. Fall below it and the home's partial loss reverts toward an ACV-style proportional payment.
The practical lesson for the exam is the same in both worlds: maintain adequate limits relative to replacement cost. Inflation guard, periodic appraisals, and replacement-cost calculators all exist to keep the insured above the threshold and avoid an unexpected shortfall at claim time.