Written by Andy Gurczak

August 1, 2021

Coinsurance: What Is It and How Does It Work?

What Is Coinsurance?

Coinsurance is an “insure to value” strategy usually employed by insurance companies. Above all, it requires you to insure your property to a minimum value percentage of its actual value. In fact, not abiding generally means a probable penalty when filing a property insurance claim.

For example, if your home value is $350,000, you must purchase at least $300,000 in coverage in order to abide by a policy containing an 80% coinsurance clause. Consequently, if you purchased less than $300,000, you will, of course, be responsible for a proportionate share of the loss. Moreover, in the case of a commercial property, coinsurance does not come into effect until a loss occurs. In fact, assessment for the replacement cost usually occurs at the time of the loss to determine the limit of insurance that should be in place. However, depending on the coinsurance percentage selected in the policy, an insured may only have to cover up to a certain amount to avoid a coinsurance penalty.

In short, insurance companies use coinsurance clauses to encourage owners to insure their properties at full value or as close to full value as possible. According to the Insurance Agents of America, most policies in fact include a “coinsurance” clause. This is so that they can determine what percentage of the value of your property you should insure in order to be fully reimbursed for a loss.


Why do insurance companies have coinsurance clauses?

  • First, insurance companies have coinsurance clauses to ensure clients have adequate coverage. To illustrate, you may not want to invest enough money to cover all of your assets, but if you ever need coverage, you’ll be happy you have adequate protection.
  • Second, to protect their pool of resources.
  • Also to encourage accurate assessment and underwriting. Because when you’re required to meet coinsurance limits, you’re more likely to make an accurate assessment of the value of your assets.

How Coinsurance Works

In order to determine deductibles, the insurer divides the amount of insurance you purchased by the amount you should have purchased. As a result, you’ll be left with the amount of your claim your insurer will pay. Generally, one of the most common coinsurance breakdowns is the 80/20 split. Under the terms of an 80/20 coinsurance plan, the insured is responsible for 20% of property repair cost. Meanwhile, the insurer pays the remaining 80%. However, these terms only apply after the insured has reached their pre-established out-of-pocket deductible amount. Most insurance policies usually include an out-of-pocket maximum that limits the total amount the insured pays.
Moreover, some policyholders choose to self-insure and rely on savings. Nevertheless, most policyholders purchase insurance with the intent to be fully covered. Subsequently, copay plans might make it easier for insurance holders to budget their out-of-pocket costs because it is a fixed amount. However, unknowing policyholders can suffer great financial hardship by not purchasing the amount of insurance required by the coinsurance provision.
With this in mind, it is important that all policyholders know if policies contain a coinsurance clause. As well as whether they have purchased the amount of insurance required to receive the full benefits they expect. Furthermore, regular appraisals can ensure that insurance limits take into account property values, inflation, and depreciation
An evaluation or appraisal should occur at least once every. In fact, this timeline may not be sufficient depending on the circumstances.

What Is the Coinsurance Formula?

In short, the coinsurance formula is the homeowner’s insurance formula that determines the amount of reimbursement that a homeowner will receive from a claim.

How the Coinsurance Formula Works?

The coinsurance formula specifically, is relatively simple. In fact, if you want to determine it yourself, you certainly can. First, begin by dividing the actual amount of coverage on the house by the amount that should be likely carried. After, multiply this amount by the amount of the loss, and this will give you the amount of the reimbursement. Consequently, if this reimbursement value is greater than the specified limits of a single insurance company, a secondary coinsurer will supply the remaining funds.

Real-World Use of the Coinsurance Formula

As previously stated, when you insure for less than the amount required by the coinsurance clause, you are basically agreeing to retain part of the risk. Thus, you become a “co-insurer” and will share the loss with the insurance company according to the coinsurance formula. Furthermore, coinsurance clauses are also found in business interruption policies. This is because these clauses ensure that policyholders insure their revenue stream to an appropriate value.


Do Courts Enforce Coinsurance Clauses?

Do Courts Enforce Coinsurance Clauses?

Some states have certainly 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 enforce them.

Avoid the Coinsurance Penalty When Making a Claim on Your Property Insurance

As mentioned above, the cost of rebuilding your property may change whether because of improvements or an increase in the cost of building materials and labor. As well as other reasons, of course. In fact, all the improvements and upgrades you make affect your insurance coverage. And when the insured limit is lower than the minimum required by your policy, payment of your claim could certainly be subject to a coinsurance penalty.

What is the Insurance Limit?

The insurance limit is the maximum amount of money that the insurer will pay for a covered loss. Usually, insurances base limits on the property’s replacement cost. Furthermore, the replacement cost is the amount of money necessary to rebuild or replace your property with materials of equal or similar quality at the time of loss.

How Can I Avoid the Coinsurance Penalty?

As mentioned above, it is important for you to review the limit on insurance periodically and determine whether the amount insured at that time is on a par with your home’s replacement cost. Get regular appraisals and report any improvements to your insurance agent. Keep any remodeling or upgrades receipts available. Furthermore, arrange assessments with your insurer. However, an assessment of the replacement cost does not include an appraisal of your property’s market value. In fact, in some cases the replacement cost could be higher than the market value, or vice versa. You should get an assessment of your property’s replacement cost to determine what it would cost to rebuild your property under current construction costs, and that number you determine your insurance policy’s coverage limit.

Coinsurance Value Reporting?

Alternatives to Coinsurance

A way to avoid coinsurance clauses is to purchase agreed value coverage. For this coverage option to apply, you must submit a statement of values to your insurer before the policy begins or renews. The statement is meant to summarize the value of your insured property. You can select to express these value in terms of replacement cost or actual cash value. Agreed value coverage applies for the term of the policy. For this reason, to continue the coverage the following policy period, you must submit a new statement of values before your current policy expires.

Another option for avoiding the coinsurance clause is value reporting. This option is typically used by businesses with property values that fluctuate due to changes in inventory. You can choose quarterly, semi-annual, or monthly reporting and then submit reports of your property values at the required intervals.

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