Do you know what commercial coinsurance is? Unlike the similarly named shared payment approach most of us know within health insurance, commercial coinsurance is used as a penalty to keep insureds honest with the levels of insurance they are buying. Since most everyone with a commercial property policy has a coinsurance exposure let's take a look at why the commercial coinsurance exists, how it works and how to avoid a penalty.
Why does commercial coinsurance exist? Commercial Property policies have various valuation methods. The two most common valuations are Replacement Cost and Actual Cash Value. Replacement Cost policies replace the property with new construction from the ground up. These values are often much higher than market value or tax value, because everything being replaced is new, creating a lot of confusion among most homeowners. Actual Cash Value is the full replacement cost, minus depreciation. This really ends up being very similar to market value, which most insureds associate with the value of their property. So why the penalty? Many insured's carry a Replacement Cost valuation policy but believe the property should be insured with a Actual Cash Value limit. They simply don't see beyond the market value and overlook depreciation. This leaves many properties under insured, insurance companies collecting too little premium, resulting in disappointed insureds at the time of loss.
How does the penalty work? The coinsurance percentage is set at the inception of the policy and can vary based on the clients' needs. For example, if you have 80% coinsurance you are required to carry at least 80% of your full Replacement Cost, Actual Cash Value, etc... valuation. At the time of loss, regardless of how big or small, the claims adjuster is going to run a property or inventory valuation to determine how much coverage you should have based on your policy type. If your carrying 80% of the full value or more, you are within the acceptable range and will not be penalized. If you are below that 80%, you will be penalized and not receive your full limit of insurance. Once it is determined that you will be penalized the adjuster will calculate your penalty by taking Did Have / Should Have X The Loss. So if at the time of loss you were carrying a $250,000 limit but should have been carrying a $500,000 limit, you will only receive 50% of your loss, minus your deductible. In that scenario if you have a $100,000 loss, you'll only receive a $50,000 payment from the insurance company minus your deductible because of the coinsurance penalty.
So how do we avoid the penalty? By understanding the valuation on your policy (replacement cost, actual cash value, etc...) and your applicable coinsurance. Many smaller BOP policies waive coinsurance all together and there are numerous endorsements that change how coinsurance is applied, complicating your understanding of what to look out for even more, and that is why choosing a trusted adviser as your insurance agent, is so very important.