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Friday
Aug082014

Control through Understanding: Coinsurance

It occurred to me that one of the reasons that people get frustrated with insurance is that they don’t understand things like coinsurance.  I was recently speaking with a prospect following the settlement of a claim.  He thought his out of pocket expenses would be limited to his $1000 deductible, but found his expenses climbed far higher when he shared in the loss because of a substantive coinsurance penalty.

Anybody who owns a building should find an explanation of coinsurance and an example helpful.  Basically, a “coinsurance” clause, determines what percentage of the value of your property must be insured in order to be fully reimbursed for a loss.  The idea is to make sure property owners aren’t underestimating or “lowballing” their property values, and then expecting to have claims settled at full price.

If you insure the property owned by your company for less than the actual replacement cost the underwriting company imposes a “coinsurance penalty” if a claim is filed. 80% coinsurance means that you must be within 80% of replacement cost, while 90% means that you must be within 90% replacement cost.  

A 100% of coinsurance clause means that you must have the building insured for 100% of the replacement cost in order to avoid a penalty!

As you would imagine; the higher the percentage of coinsurance, the lower the property rate and premium.

In other words, if you insure your building for half of what an adjuster determines it would cost to replace it, the underwriting company assumes that they are insuring half, and your company  is insuring half.  If a tornado takes out 50% of the building, they expect to kick in for the half they insure, and they expect you to pick up the other half. (I’ve tried telling adjusters the tornado took out their half, and our half is fine, but it doesn’t work)

Here is an example for a company I’ll call Pseudo Co 

Let’s say the Pseudo Co. building has an estimated replacement cost of $1,000,000 and their policy has a coinsurance value of 80%.  So, they insure the building for $800,000 thinking they have fulfilled the coinsurance clause by coming within 80% of the replacement cost. 

A fire causes $600,000 worth of damage so they submit a claim. The claims adjuster for the underwriting company subsequently determines that the replacement cost of the entire building is actually $1,500,000.  They should have insured for 80% of $1,500,000. 

To determine how much to pay on the claim, the claims adjuster divides the amount of insurance Pseudo Co. purchased (80% of $1,000,000, or $800,000) by the amount they should have purchased (80% of $1,500,000 or $1,200,000). Their $800,000 is two thirds of the $1,200,000 they needed in place to be fully insured.

The result (two-thirds, or $400,000) is the amount of that claim the insurer will pay! Then Pseudo Co. will be on the hook for the rest.  If the building had been insured for at least $1,200,000, the insurer would have reimbursed them for the full amount of the loss.  

Like many aspects of insurance, once you understand coinsurance, it isn’t as tricky.  But you can certainly see how not keeping up on these values could end up costing a building owner an incredible amount of money.  We work with our clients, before a claim, to make sure that the coinsurance clauses and property values on the policies will provide adequate coverage.

While competitive premiums are an important factor in buying insurance, it is important to understand what coverage you do, and do not, carry.

At Ellerbrock-Norris Insurance Agency this is a conversation we would all prefer to have prior to a claim situation. 

 

 

 

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