Risky Business: Coinsurance 101

Coinsurance can be a bit confusing, and we are seeing it more and more on commercial property policies so we should take a minute to understand what it means.

In the simplest of terms, coinsurance is the carrier’s way of making sure that the insured has adequate limits for their property and if they don’t, there is a penalty at the time of loss. 

The coinsurance provision requires that the insured carry coverage equal to a specified percentage of the property’s value, typically 80% or 90%. The valuation used, whether it’s replacement cost or actual cash value, depends on the policy.

So, let’s math this. (I love this part!)

• The replacement cost value (RCV) of a property is $1,000,000.
• The insurance policy carries a limit of $800,000.
  • $800,000 / $1,000,000 = 80% (So the insured is carrying 80% of the property’s value)
  • Still with me?
• The policy includes a 90% coinsurance provision
  • This means that the insured is required to carry at least $900,000 in coverage (90% x $1,000,000)
  • If the limit carried is less, a penalty may be applied in the event of a partial loss
• There is a loss in the amount of $200,000
• The penalty is based on carried vs. required insurance
  • Coinsurance formula:

                                              (Carried/Required) x Loss = Payment

• In this scenario:

                                             (800,000/900,000) x 200,000 = 177,778

• This means the claim payment would be $177,778 (before any deductible) rather than $200,000

Coinsurance penalties primarily affect partial losses rather than total losses BUT, you may be surprised to find that most property losses are partial, so this is a very real concern.

In a total loss, the policy limit is the ceiling and typically caps recovery, so the coinsurance calculation often doesn’t further reduce the payment.

Also important to note:

The coinsurance calculation is based on the property’s value at the time of the loss, not when the policy was bound. This distinction matters as property values can increase, as can the cost of materials. (Think Covid-era cost inflation)

Some policies include an Agreed Value provision which suspends the coinsurance penalty for that policy term if the insured and carrier agree on a limit and that limit is maintained. For lenders who require coinsurance-free policies, an Agreed Value provision is worth looking for — but it must be actively maintained. At each renewal, the insurer typically requires updated values and will only continue the provision if the reported values support the policy limit. If not, the provision is removed and the coinsurance clause applies again, which is why reviewing the policy at each renewal is critical.

Does your head hurt yet? Listen, we don’t have to memorize the math. (I was kidding, I don’t really love that part.) What we need to understand is that coinsurance potentially leaves a gap in coverage, which could put our lender’s collateral at risk if the borrower doesn’t have the funds to cover the difference. Our role is to recognize risks early and ensure that property values and limits are aligned, helping protect both the borrower and the lender.

Until next time! MM