Letters! Coinsurance

I get emails every week asking questions. Here is one I got Friday…

I teach commercial insurance at a University in Puerto Rico. As I’ve learned, the coinsurance clause cannot by applied when a total loss occurs. However, one of my students indicates a main insurer in applying the clause to total loses. A specific case is a House insured for $100,000. The Insurer evaluate the value of the house at $200,000 at the time of loss. There was a total loss. The insurer is paying only $50,000. alleging a coinsurance penalty of 50%.

My thesis is that paying the insurance amount of $100,000 the insured is already sharing a 50% of the loss, which is the coinsurance penalty.

Please clarify this issue for me and my students.

My Reply: Well, you ask a complicated question….

First, in US Homeowners insurance policies (ISO HO3 form for example) the coinsurance clause does not work as standard fire policies do. The HO coinsurance is the removal of replacement cost coverage if you are under insured.

On standard fire policies The coinsurance clause applies to every loss (unless there is an agreed amount endorsement). The mathematics usually works so there is no coinsurance penalty in a total loss – the penalty is the fact that the insured does not have enough coverage to rebuild.

Example:

$1,000,000 building (replacement cost),

80% coinsurance (should buy $800,000),

Limit purchased $600,000,

Loss Formula = $600k divided by $800k (3/4) times the loss

So, on a $100,000 loss the payment would be 3/4 of the $100k or $75,000 On a total loss of $1,000,000 the payment would be $600k policy limit.