Understanding the Coinsurance Clause
The Coinsurance clause is one of the most critical concepts for anyone studying for their Property exam. Its primary purpose is to encourage policyholders to insure their property to its full value, or at least a significant percentage of it. Most commercial and some homeowners policies include a coinsurance requirement—typically 80%.
When a property owner carries a limit of insurance that is less than the required percentage of the property's actual value at the time of loss, they become a "co-insurer" with the insurance company. This means they must share in the cost of any partial loss. Understanding this formula is essential for passing the practice Property questions you will encounter during your studies.
The 'Did / Should' Formula
The formula used to determine the amount an insurer will pay for a partial loss is often referred to as the 'Did over Should' formula. It follows this mathematical structure:
- (Amount Carried / Amount Required) x Amount of Loss = Claim Payment
To calculate the 'Should' (Amount Required), you multiply the Replacement Cost or Actual Cash Value of the property at the time of the loss by the coinsurance percentage specified in the policy (e.g., 80%).
Note: If the result of this formula is higher than the policy limit, the insurer will never pay more than the face amount of the policy. Also, the deductible is usually subtracted after the coinsurance calculation is performed.
Key Formula Components
Step-by-Step Calculation Example
Let's look at a scenario likely to appear on a licensing exam:
- Property Value: $100,000
- Coinsurance Requirement: 80%
- Insurance Carried: $40,000
- Amount of Loss: $10,000
Step 1: Determine the 'Should'. $100,000 (Value) x 0.80 (Requirement) = $80,000. The insured should have carried at least $80,000.
Step 2: Apply the Formula. (Did $40,000 / Should $80,000) = 0.50 or 50%.
Step 3: Calculate the Payout. 50% of the $10,000 loss = $5,000.
In this case, the insured only receives $5,000 (minus any deductible) because they were only carrying half of the required insurance amount. They must pay the remaining $5,000 out of pocket as a coinsurance penalty.
Adequate Insurance vs. Underinsurance
| Feature | Scenario | Calculation Result | Insurer Payout |
|---|---|---|---|
| Insured at 80%+ | Ratio is 1.0 or higher | 100% of partial loss (up to limit) | |
| Insured at 50% of req. | Ratio is 0.50 | 50% of partial loss | |
| Total Loss (Underinsured) | Formula is bypassed | Face amount of policy limit |
Exam Tip: The Total Loss Exception
A common trick question on the Property & Casualty exam involves a total loss. If the property is completely destroyed, the coinsurance formula is not applied. In a total loss, the insurer simply pays the limit of the policy (the face amount), regardless of whether the insured met the coinsurance requirement or not.
Why Insurance Companies Use Coinsurance
Insurance rates are based on the assumption that most losses are partial, not total. If everyone only insured their buildings for 20% of their value (knowing that most fires only cause partial damage), the insurance company would not collect enough premium to cover those frequent partial losses. The coinsurance clause ensures that the premium collected is proportional to the actual risk being transferred.
By enforcing this clause, insurers encourage policyholders to keep their limits updated as property values increase due to inflation or renovations. For exam purposes, always remember that the property value used in the 'Should' calculation is the value at the time of loss, not the value when the policy was originally purchased.
Frequently Asked Questions
If you carry more than the required 80% (for example, you carry 90%), the formula results in a ratio greater than 1.0. However, the insurer will never pay more than the actual amount of the loss or the policy limit. You simply get the full amount of your partial loss (minus the deductible).
On most standard ISO forms used for exams, the coinsurance calculation is performed first to determine the 'limit of recovery.' Then, the deductible is subtracted from that amount.
No. In the event of a total loss, the insurer pays the face amount of the policy. The coinsurance penalty is only relevant for partial losses where the insured failed to meet the required insurance-to-value ratio.
In both commercial and residential property insurance, 80% is the standard requirement. However, some policies may offer 90% or 100% requirements, often in exchange for a lower premium rate.