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One of the most complicated and most frequently misunderstood elements of commercial property insurance is the coinsurance factor and its penalty formula. Coinsurance can be described as a property insurance provision that imposes a penalty on an insured's loss recovery, on any size claim, if the limit of insurance purchased is not at least equal to the specified percentage (coinsurance percentage) of the value of the insured property.

Why is a coinsurance provision necessary? It is well established that most building property losses are partial in that they do not result in the total destruction of the structures involved. For an insured who recognizes this, there may be a tendency to play the odds and limit the amount of insurance purchased. Why pay the premium for full coverage when chances are the full amount may never be needed? Of course, when the property is pledged as security for a mortgage loan, the mortgage company usually requires that the property be insured for an amount that will at least cover the balance of the mortgage. Oftentimes however, the mortgage is less than the replacement cost of the structure.

Since it is true that most losses are partial, individuals who purchase full coverage ordinarily would pay an inordinately higher premium than those who play the odds and limit the amount of their insurance. Therefore, an insured with full coverage would pay an inequitable premium. In an effort to avoid this inequity, and to encourage the insured to carry a reasonable amount of insurance in relation to the actual cash or replacement value of their property, a coinsurance requirement is incorporated into almost all commercial property insurance policies. The insured receives the benefit of a reduced rate when the limit is equal to a specified coinsurance percentage (commonly 80% to 100%).

The rates ordinarily used for insuring commercial buildings and personal property are calculated with the assumption that they will be used with a coinsurance provision. When a policy contains a higher coinsurance percentage, the property rates are reduced to encourage the insured to purchase higher limits. Therefore, with 90% or 100% coinsurance, the insured must purchase a greater amount of insurance to comply with coinsurance, but the rate is reduced. When there is no coinsurance requirement, or when it is less than 80%, the rate is increased.

The catch is if the insured does not acquire the proper limit of insurance for the property, a penalty is assessed on any and all claims made against the policy. So an insured, playing the odds and knowingly (or inadvertently) under insures their property, may be surprised, when submitting a partial claim, that the check is far less than anticipated. Repairs will have to be partially paid for outside of the insurance, much like an additional deductible. The following is how it works.

*Example -- A business partially insures property worth $250,000 for $100,000 , with a policy that requires at least 80% of its value to be insured for full coverage. There is a $1,000 deductible. The insured experiences a $20,000 loss. Since the amount of insurance required for full coverage is .80 x $250,000 = $200,000 , and the current coverage is $100,000, the business would have to pay 1/2 of that loss. Using the equation above, $20,000 (loss) x $100,000 / $200,000(1/2 required coverage) - $1,000 (deductible)= $9,000, ( what the insured recovers).

There are no restrictions in the property policy for setting the limit of insurance on your property, only a penalty if you don't set it at the correct limit. You should know what your coinsurance percentage is in your policy and how your current values relate to that percentage. If you have any questions about your particular policy please don't hesitate to contact us

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