Co-insurance is arguably one of most commonly misunderstood and confusing concepts in insurance. We want to help you understand by explaining what co-insurance is and how it works.
What is co-insurance?
Co-insurance is a clause used by insurance companies on policies covering property such as buildings, contents, stock, or industrial equipment. This clause makes sure policyholders insure their property to an appropriate value and that the insurer receives a fair premium for the risk, whether on a replacement cost basis or on an actual cash value basis (subject to depreciation). The co-insurance clause can also be found on business interruption policies where it ensures that policyholders insure their revenue stream to an appropriate value.
How does co-insurance work?
Generally, co-insurance is expressed as a percentage. The most common clauses require policyholders to insure to 80%, 90%, or 100% of the true value. For instance, a building valued at $1,000,000 replacement value with a co-insurance clause of 90% must be insured for no less than $900,000. The same building with an 80% co-insurance clause must be insured for no less than $800,000.
What if I choose to insure for less than the amount required by the co-insurance clause?
If a property owner chooses to insure for less than the amount required by the co-insurance clause, the property owner is essentially agreeing to retain part of the risk rather than transfer it to the insurance company. He or she thus becomes a ‘co-insurer’ and will share the loss with the insurance company according to a simple calculation.
Here are two examples that demonstrate how the clause works:
Building Value $1,000,000
Co-insurance Requirement 90%
Required Amount of Insurance $ 900,000
Actual Amount of Insurance $ 600,000
Amount of Loss $ 300,000
The co-insurance formula is:
(Actual Amount of Insurance ) X Amount of Loss = Amount of claim
(Required Amount of Insurance)
Inserting the amounts above in the formula produces the following calculation:
($600,000) X $300,000 = $200,000
So the owner absorbs a $100,000 co-insurance penalty. Since he chose to retain one-third of the risk himself rather than transfer it to the insurer, he absorbs one-third of the loss.
If the building had been insured to the amount required by the 90% co-insurance clause then the co-insurance calculation would look like this:
(Actual Amount of Insurance) X Amount of Loss = Amount of claim
(Required Amount of Insurance)
($900,000) X $300,000 = $300,000
In the second example, since the owner met the co-insurance requirement, he was not a coinsurer and his claim is paid without penalty.
Will insurance companies allow the deletion of the co-insurance clause?
Generally, insurers will not allow the co-insurance clause to be deleted. They want to ensure they receive a premium which fairly reflects the total reconstruction value of the property insured, and covers the risk assumed by the insurer. Under certain circumstances, an insurer will replace the percentage co-insurance clause with a “stated amount co-insurance” clause.
With the stated amount co-insurance clause, a pre-agreed value replaces the percentage amount. As long as the amount insured is not less than the amount agreed to, the property owner cannot become a co-insurer and won’t face the penalties created by underinsurance. If the property is insured for less than the agreed value, the stated amount co-insurance clause reverts to the standard 90% clause – and the potential for an underinsurance penalty returns.
To obtain the stated amount co-insurance clause, the policyholder must satisfy the insurer the amount of coverage is a fair approximation of the true cost. Normally, a “reconstruction appraisal” will be required. Market value or purchase price can be dramatically different from replacement cost. Relying on them can produce some nasty surprises following a loss.
When will the different co-insurance percentages be used?
80% is normally used:
• for property insured on an actual cash value (depreciated value) basis.
• for stock in trade.
• for gross earnings business interruption.
90% is normally used:
• for buildings and contents insured for replacement cost.
• for industrial equipment.
100% is normally used:
• for profits business interruption.
There are other percentages and applications used. It is best to confirm with your BrokerLink broker on how co-insurance might affect you. Your broker will advise you of the steps to take to ensure your property is insured to a fair value and you won’t end up on the wrong side of a co-insurance calculation.