What Are Coinsurance Clauses and Do Courts Enforce Them?
Many insurance policies contain coinsurance clauses which require policyholders to purchase an amount of insurance that accurately reflects the value of their insured property. If less than a certain percentage of the accurate value is purchased, policyholders may not be able to fully recover in the event of a loss..
Coinsurance clauses can be confusing and often leave policyholders in distress. The good news for policyholders is that a little education can go a long way in this area of insurance law. If you understand the basic principle that you must maintain insurance on a certain percentage of the value of your property, then you will be fully insured when disaster strikes.
WHAT IS COINSURANCE?
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.. For example, if a building valued at $250,000 is insured with a policy containing an 80% coinsurance clause, the policyholder must purchase at least $200,000 in coverage. If the policyholder purchased less than $200,000, he or she would be responsible for a proportionate share of the loss.
IS A COINSURANCE CLAUSE VALID?
Most commonly, yes. Some states, including Kentucky, have passed statutes voiding coinsurance clauses in property insurance policies which insure risks associated with fire or storm damage on real property. However, in states that have not passed a statute prohibiting coinsurance clauses, courts follow the common law and uphold them.
HOW IT WORKS
The basic formula for determining whether you have enough coverage is:
Actual Amount of Insurance divided by the Required Amount of Insurance then multiplied by the Amount of Loss. This equals the amount the insurance company will pay, less any applicable deductible.
More plainly, let's assume we have a building valued at $100,000. Under an 80% coinsurance clause, an insured would be expected to insure 80% of these values, or $80,000.
Now, let's consider two scenarios, the amount of the loss in each case is $30,000:
First, the policyholder only carries $50,000 in coverage:
($50,000/$80,000) x $30,000 = $18,750 (less deductible). The policyholder is forced to pay, or self-insure, the shortfall of $11,250.
Second, the policyholder carries the full $80,000 required under his policy:
($80,000/$80,000) x $30,000 = $30,000 (less deductible). In this example, the policyholder would receive full benefits.
Some policyholders choose to self-insure and rely on savings. However, most policyholders purchase insurance with the intent to be fully covered. As the examples illustrate, the unknowing policyholder can suffer great financial hardship by not purchasing the amount of insurance required by the coinsurance provision.
It is important that all policyholders know whether their policies contain a coinsurance clause and, if so, whether they have purchased the amount of insurance required to receive the full benefits they expect. Regular appraisals can ensure that property values, inflation, and depreciation are taken into account in your insurance limits. An evaluation or appraisal once every three years is a good rule of thumb, but may or may not be sufficient depending on the circumstances.
Thanks for this clear explanation of coinsurance. You may enjoy the following (not so clear) explanation that was given by a Florida insurance agent in a deposition. I title this, "How Not to Explain Coinsurance..." - "I would -- I would tell her about the differences within 80, 90 and 100 percent coinsurance -- in the best way I can for them to understand. It would be that the property or each building would have to be insured at the correct value. I would also say to the customer what is the correct value. I will also say this, you know, you can hire seven different appraisers and they're all going to come up with different numbers -- but, from an insurance standpoint, a hundred percent coinsurance would be that we need to make sure that the buildings are correctly valued at today's numbers -- The importance of a hundred percent -- 90/80 – is the coinsurance penalty. And -- and I would probably, at this time, would do an example with them of a penalty if a -- if a building would be under -- undervalued. The -- obviously, if they -- if the loss is such amount and at the time of the loss the building is -- has such amount limit covered, but the -- at the time of the loss, the value of that building is higher, then that higher limit of the actual value of that -- of that building, at the time of the loss, if it's higher than the actual coverage, then it is not a hundred percent. The higher the value outside the market, then the percentage, then, starts going down. If, for example -- if I'm insuring the building at 100,000 but then it comes out to be that the building to replace would be 150,000, then we would find out the percentage of the claim to see what would be the undervalue. However, the -- you know -- and I will explain this, too -- and say, hey, you can, right now, hire three different appraisers and it will be different numbers. We try to come up with the best we can what the insurance company accepts and -- and send people to the property to make sure everything is correct. I am not an appraiser, obviously, but the -- Yeah. I mean, I -- I'm trying to put words that I -- that the customer can understand by -- by appraisers and -- and formula explanation with an example. I think that's the best way to explain it to them."
Note that in New Zealand it is unlawful for insurers to imppose Average in any residential or domestic contents insurances. Coverage can be restricted or deductibles imposed, but no Average
John Sloan
Wellington
New Zealand
Some insurance companies do not offer a co-insurance provision. Typically surplus lines carriers enforce it where allowed.
Thank you for the excellent explanation of the 80% coinsurance. We just purchase a new home and we had three quotes by reputable agencies. All had this clause but no one gave us an explanation or went over their quotes with us. Thanks to you, we now can negotiate and get an insurance that will fit our needs and our budget.