In a recent deposition in an insurance producer malpractice case, the producer was asked about the purpose of co-insurance and how our insured would be impacted under the provision if the building was underinsured. Unfortunately, the producer was unable to explain how the co-insurance provision worked or how the insured could be penalized. This prompted me to think maybe it’s time for a property co-insurance refresher.

‘Coinsurance clauses in substance require the insured to maintain insurance on the property covered by the policy in a certain amount, and stipulate that upon his failure to do so, the insured shall be a coinsurer and bear his proportionate part of the loss on the deficit.’ . . . For example, ‘[I]nsurance policies that protect against hazards such as fire or water damage often specify that the owner of the property may not collect the full amount of insurance for a loss unless the insurance policy covers at least some specified percentage, usually about 80 percent, of the replacement cost of the property.’ . . . Coinsurance clauses are designed to induce the insured to carry full, or nearly full coverage, and are generally held enforceable unless they are specifically prohibited by statute in the jurisdiction.**1

In a commercial property policy, the co-insurance provision comes take affect when a loss occurs. If the property is under insured, the insured may incur a co-insurance penalty on a partial loss (it does not come into play on a total loss). So, it is important the insured maintain a sufficient amount of coverage.

Say you own a building with a replacement cost value of $1,000,000, and your policy has an 90% coinsurance provision. You must insure the property for at least $900,000 to comply with the co-insurance provision. For whatever reason, you only insure the property for $500,000. When you have a partial loss, the insurance company will look at the ratio of the amount of coverage, divided by the coinsurance requirement (here 500,000/900,000 = .56). If your loss was $500,000, the insurer will pay $500,000 x .56 = $280,000 (less any applicable deductible). As you can see, the coinsurance penalty can be significant.

Make sure you know if there is a coinsurance provision in your policy, and it you cannot have the provision taken out make sure you understand the consequences of having too little property coverage.

Footnotes:

Surratt v. Grain Dealers Mut. Ins. Co., 74 N.C.App. 288 (1985) (quoting 44 Am.Jur.2d Insurance Sec. 1510 at 505-06, and Black’s Law Dictionary 236 (rev. 5th ed. 1979)).

Excerpts from the Policy in question:

1. Replacement Cost–Coverages A and B:
This condition shall be applicable only to a building structure covered hereunder excluding….

a. If at the time of loss the whole amount of insurance applicable to said building structure for the peril causing the loss is 80% or more of the full replacement cost of such building structure, the coverage of this policy applicable to such building structure is extended to include the full cost of repair or replacement (without deduction for depreciation).

b. If at the time of loss the whole amount of insurance applicable to said building structure for the peril causing the loss is less than 80% of the full replacement cost of such building structure, this Company’s liability for loss under this policy shall not exceed the larger of the following amounts (1) or (2):

        (1) the actual cash value of that part of the building structure damaged or destroyed; or

        (2) that proportion of the full cost of repair or replacement without deduction for depreciation of that part of the building structure damaged or destroyed, which the whole amount of insurance applicable to said building structure for the peril causing the loss bears to 80% of the full replacement cost of such building structure.