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Coinsurance Primer

November 14, 2017

Ever heard anyone talk trash about their insurance? Quite often, it’s because they thought their policy covered something that it didn’t. When a claim doesn’t pay what they expect, it can lead to anger and frustration. This also serves to give the insurance industry a bad rap.

Coinsurance is a common source of this confusion. So to help clear things up, we’re devoting Part 3 of our Commercial Lines Rating Series to the topic of coinsurance. In this post, we’ll provide several ways to explain this frequently misunderstood term.

Coinsurance written on a note padCoinsurance is one of the several factors that come into play in determining a rate

 

Related:
WSRB's Essential Guide to Commercial Property Risk Assessment

 

Most property insurance policies contain a coinsurance provision, which requires the policyholder to insure the covered property at a certain percentage of the total insurable value — typically 80, 90 or 100%. Meeting a coinsurance provision allows the insured to receive the full amount of a partial-loss claim.

In property insurance, coinsurance exists because premiums are based on two factors: the loss amount and the frequency of loss.

Total losses are more costly, but they happen less often than partial losses. Without coinsurance, property owners would be tempted to insure for partial losses only. It makes sense: the risk of total loss is unlikely, and since the amount insured is less, their premium should theoretically be lower.

But if insurance companies calculated premiums for partial losses, those who wanted full coverage would pay a higher premium than the coverage would otherwise command. To correct this inequity, this is where coinsurance comes in.

Coinsurance, risk and reward

Coinsurance helps even out the risk and reward. With coinsurance, the premium per $100 of property value is less for a total loss, and more for a partial loss.

By requiring underinsured claimants to pay more, coinsurance helps achieve equity in rating. It also encourages owners to maintain adequate insurance on their properties.

In other words, the coinsurance provision:

  • Helps achieve rate equity and adequacy.
  • Assists in keeping insurance premiums affordable.

In his Insurance Journal article, Coinsurance: The Property Insurance Version of a 4-Letter Word, Christopher Boggs provides an exceptional explanation of the importance of coinsurance and the specific reasons why it’s needed.

If you don’t have time to read the article, the big takeaway is that the coinsurance provision allows “insurers to keep property rates lower than they otherwise could if insureds were allowed to purchase whatever amount of coverage they so desired without penalty, regardless of the total insurable value of the structure being protected.”

By requiring the insured party to pay the percentage of their losses proportional to the amount of the underinsurance, coinsurance removes the economic incentive to underinsure a property. As a result, fewer properties are underinsured.

We all know rates are based on rules. The Commercial Lines Manual (CLM), Division 5, states 80% rates can be converted as follows:

  • For 90% coinsurance, apply a factor of .95 (translation for the insured, that is a 5% credit).
  • For 100% coinsurance, apply a factor of .90.

Let’s look at an example of coinsurance in effect. The table below compares an adequately insured property with an underinsured one, using Building & Personal Property coverage form CP 00 10 Section F, Additional Conditions.

Example No.  1 (Adequate Insurance):

Example No.  2 (Underinsurance):

When:

The value of the property is:

The coinsurance percentage is:

The limit on insurance for it is:

The deductible is:

The amount of loss is:

 

$250,000

80%

$200,000

$250

$40,000

When:

The value of the property is:

The coinsurance percentage is:

The limit of insurance for it is:

The deductible is:

The amount of loss is:

 

$250,000

80%

$100,000

$250

$40,000

Step 1: $250,000 x 80% = $200,000 (the minimum amount of insurance to meet your coinsurance requirements)

Step 2: $200,000 ÷ $200,000 = 1.00

Step 3: $40,000 x 1.00 = $40,000

Step 4: $40,000 - $250 = $39,750

Step 1: $250,000 x 80% = $200,000 (the minimum amount of insurance to meet your coinsurance requirements)

Step 2: $100,000 ÷ $200,000 = .50

Step 3: $40,000 x .50 = $20,000

Step 4: $20,000 - $250 = $19,750

The insurance company covers the $39,750 loss in excess of the deductible. No penalty applies.

The insurance company pays no more than $19,750 of the loss in excess of the deductible. The remaining $20,250 is not covered.

 

Coinsurance formula

Let’s translate the above example into the coinsurance formula:

(Amount of Insurance written ÷ Required Amount of Insurance) x Loss - Deductible = Payment

Also known as  (DID/SHOULD) X  LOSS  –  DEDUCTIBLE  =  LOSS PAYMENT

Hopefully, these explanations give you the ability to explain the basics of coinsurance, so you can help your customers better understand the need for this provision and their policy coverages. A good grasp on coinsurance allows them to make more informed decisions, while helping portray our industry in a positive light.

Terry Krueger is WSRB's Senior Subscriber Services Analyst. She joined WSRB in 2005 after many years in the insurance industry, where she worked in both commercial lines rating and underwriting. Terry is a natural problem solver, a lover of bowling and puzzles and the author of some of our most popular educational blog posts.

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