How does co-insurance work in property insurance?

Co-insurance is a common clause in commercial and personal property insurance policies that requires the policyholder to carry a certain percentage of the property's value in insurance coverage. This clause is designed to ensure that the policyholder carries an adequate amount of insurance, encouraging them to fully insure their property rather than underinsuring it.

How Co-Insurance Works?

• Co-Insurance Percentage: This is the percentage of the property’s value that the policyholder must insure. Common co-insurance percentages are 80%, 90%, or 100%.

• Replacement Cost: This is the cost of replacing the property with like kind and quality at today’s prices without considering depreciation.

• Calculation of Adequate Coverage: To avoid a penalty in the event of a claim, the policyholder must insure the property for at least the co-insurance percentage of the property's full replacement cost.This insurance covers the costs of legal defense, settlements, and judgments, which can be exorbitant, even for seemingly minor claims. Without this coverage, professionals could face devastating financial losses, potentially bankrupting their practices and damaging their reputations beyond repair.

Example Scenario:

Let's consider your example with an 80% co-insurance clause:

• Property Value (Replacement Cost): $1,000,000

• Co-Insurance Percentage: 80%

To meet the co-insurance requirement, the property should be insured for at least 80% of its replacement cost.

Adequate Coverage=Replacement Cost×Co-Insurance Percentage

Adequate Coverage=$1,000,000×80%=$800,000

This means the property owner should carry at least $800,000 in coverage.

How Co-Insurance Affects Losses

If the property owner insures the property for less than the required co-insurance amount, they may face a co-insurance penalty when filing a claim. The penalty reduces the claim payout amount and is calculated by comparing the actual insurance carried to the required amount.

For instance, if the owner had only insured the property for $600,000 instead of $800,000, and then suffered a loss, the insurance payout would be reduced. The insurance company would only pay a proportion of the claim, based on the ratio of the actual coverage to the required coverage.

Here’s how it would work:

• Determine the Co-Insurance Penalty:

  Co-Insurance Penalty Ratio = Required Coverage / Actual Coverage 

  Co-Insurance Penalty Ratio = 600,000 / 800,000 =0.75

• Apply the Penalty to the Loss:

  If the loss was, $200,000, the insurance would only cover 75% of that amount, or $150,000.

Consult A Professional

To avoid a co-insurance penalty and ensure full coverage in the event of a loss, the property should be insured for at least the co-insurance percentage of its full replacement cost. In your example, this means having at least $800,000 in coverage on a property valued at $1,000,000 under an 80% co-insurance clause. 

If you have any questions contact your agent Stephen Lim at 312-535-7347 or email him at slim@zhouagency.com with any questions you may have about co-insurance.

Stephen Lim

Property & Casualty Insurance Account Manager

Stephen Lim comes to our agency with a breadth of experience in the Commercial Insurance markets. With a B.S. in Business Administration from Cal Poly Pomona and years of risk management experience, he has extensive knowledge and experience in business development and insurance placement and management services. He always puts the clients' best interests first and strives to provide exceptional customer relations.

312-535-7347 | slim@zhouagency.com

This post is to be used for informational purpose only and does not constitute legal, business, or tax advice. Each person should consult his or her own accountant, attorney, or business advisor with respect to matters referenced in this post. Zhou Agency assumes no liability for actions taken in reliance upon the information contained herein.