Don’t ignore the fine print! If the devil is in the details, there's one section found in nearly every type of property insurance policy that you’d be wise to become familiar with.
Whether it’s your Homeowners Policy or Commercial Property Policy, you need to understand this critically important section of your policy. It’s usually found in the “Conditions” and at first glance, may seem rather harmless.
What is it?
It’s called Coinsurance.
If you’re not intimately familiar with coinsurance, you likely have never been a victim of the penalty. Rest assured, that’s a good thing. A very good thing, because this one little section of your policy can have a drastic impact on how you’re compensated after a claim.
So what exactly is coinsurance? Well first of all, you need to understand that we’re not talking about coinsurance in the same sense as what you’re likely familiar with in your health insurance coverage. In the Property & Casualty world, as an insured, you don’t want to deal with coinsurance… ever!
As mentioned previously, coinsurance is most often found in property policies, such as homeowners insurance, or commercial property insurance.
We’ll start with the technical explanation…according to the International Risk Management Institute, coinsurance is:
"A property insurance provision that penalizes the insured's loss recovery if the limit of insurance purchased by the insured is not at least equal to a specified percentage (commonly 80 percent) of the value of the insured property. The coinsurance provision specifies that the insured will recover no more than the following: the amount of the loss multiplied by the ratio of the amount of insurance purchased (the limit of insurance) to the amount of insurance required (the value of the property on the date of loss multiplied by the coinsurance percentage), less the deductible."
Don’t worry, you’re not alone. Many licensed insurance agents don’t understand this vitally important section of the policy which is where the real problem exists: if your agent doesn’t understand this critical element of your policy, how can it be properly explained to you? We’ll address that problem later. For now, let’s focus on precisely what coinsurance means to you.
Simply stated, the coinsurance section of your policy gives your insurance company the right to penalize you by reducing the amount of your claim payment in the event the amount of insurance you purchased is inadequate. In most policies, the standard amount of insurance that must be purchased is equal to 80% of the replacement value of the property. This figure is referred to as the coinsurance percentage. Sounds fairly abstract, right?
The Insurance Policy Language
Can you ever imagine an instance where you’re sitting down, actually reading your insurance policy? Perhaps if you’re having trouble falling to sleep at night… but in this case, it’s helpful to see the actual wording from the policy so we can further understand this often confusing concept:
If a Coinsurance percentage is shown in the Declarations, the following condition applies
a. We will not pay the full amount of any "loss" if the value of Covered Property at the time of "loss" times the Coinsurance percentage shown for it in the Declarations is greater than the Limit of Insurance for the property. Instead, we will determine the most we will pay using the following steps:
(1) Multiply the value of Covered Property at the time of "loss" by the Coinsurance percentage;
(2) Divide the Limit of Insurance of the property by the figure determined in step (1);
(3) Multiply to the total amount of "loss", before the application of any deductible, by the figure determined in step (2); and
(4) Subtract the deductible from the figure determined in step (3)
We will pay the amount determined in step (4) or the Limit of Insurance, whichever is less. For the remainder, you will either have to rely on other insurance or absorb the "loss" yourself
Well if you weren’t scratching your head before, how do you feel now? Starting to understand why this coinsurance issue causes problems for so many people?
Unfortunately, since it’s so often misunderstood, it’s not properly explained to those that purchase the policy and therefore, it leaves you to suffer substantial consequences if you have a claim and it’s determined that you did not comply with the coinsurance requirement.
What's the bottom line?
Let’s review a real-world example. This information is based on an actual client of Hill & Hamilton Insurance (the name has been changed of course).
Prior to becoming a client, he contacted us and asked us to review his insurance policies with him. He felt that he was paying too much for his insurance.
After a comprehensive review, he was paying substantially more than he should have been but not in terms of his annual premium. What we found was that he was in violation of his coinsurance clause and had a claim occurred, he would have been paid substantially less than what he thought he would receive.
Essentially, he was paying a premium for coverage amounts he would never receive. You might be wondering, how is that possible? Well here are the details:
- Fred was insuring his house for $114,500
- His policy had a coinsurance percentage of 80%
- Fred had a $1,000 deductible on his policy
- For purposes of this example, we will assume Fred had a $20,000 claim when hail damaged his roof and his vinyl siding
We discovered the first problem with Fred’s policy and that was, when he purchased his house back in 1991, he bought the insurance policy with the limit of coverage being required by his bank.
Sounds pretty familiar, right? So where’s the problem? The bank only required his insurance to be in the amount of his mortgage, not the actual replacement value of his house. And to top it off, Fred’s homeowners policy was not keeping up with inflation over the years.
How does that translate to actual dollars? When we insured Fred’s house, the replacement value was determined to be $217,000.
Here’s what would have happened in the event that $20,000 claim occurred BEFORE we fixed Fred’s policy:
According to the coinsurance clause, we have 4 steps to follow:
- Multiply the value of the covered property ($217,000) by the coinsurance percentage (80%), resulting in an amount of $173,600. This is the least amount of coverage Fred should have had in place to avoid the coinsurance penalty.
- Divide the actual limit of insurance of the property ($114,500) by the figure determined in step 1 ($173,600), which results in .659 or roughly 66%
- Multiply the total amount of the loss ($20,000) by the figure determined in step 2 (66%) and you get $13,200
- Subtract the deductible ($1,000) from the amount determined in step 3 ($13,200) to finally arrive at $12,200
And the results are...
Simply stated, a very unhappy individual (Fred) receiving the phone call of bad news if he had experienced a loss under his old policy. Since no one ever explained the details of the coinsurance provision to Fred, he simply thought if he had a $20,000 claim, he would be paid $19,000 after he paid his $1,000 deductible.
The fact is, Fred would only have received $12,200… a full $6,800 less than he expected to receive simply because he was subject to the coinsurance penalty. Without his knowledge, Fred’s deductible (in this hypothetical claim) wasn’t $1,000, it was actually $7,800!
So what can you do?
The short answer is, make sure your coverage meets the coinsurance requirement. The fact is, your insurance agent should be discussing this with you.
Too often, agents try to cut the cost of the policy by reducing the coverage offered. It might not seem like a big deal and chances are, you would probably be comfortable with the limit of coverage being recommended. However, the devil in the details could severely impact your coverage in the event of a claim.
This is precisely why you deserve, and should expect, to work with a trusted insurance advisor. Insurance is very similar to so many other products you likely purchase on a daily basis… you get what you pay for!
If you’d like to learn more about the coinsurance section of your policy, and how it could impact your specific situation, contact one of our Licensed Advisors or complete the form above. We’re here to help.
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