Does your property insurance policy include a coinsurance clause? Not sure what it is? You’re not alone.
In the context of your commercial property policy, coinsurance is the percentage of property value you’re required to insure. For example, if your policy has an 80 percent coinsurance provision, the limit of insurance you purchase must be at least 80 percent of your building’s replacement cost value.
If you purchase a coverage limit less than 80 percent, any future claim payment will be reduced in proportion to the deficiency. That means if you don’t have adequate coverage for your buildings and business personal property and you sustain a loss, you’ll be subject to a coinsurance penalty.
Two owners, two outcomes
Let’s look at two examples using fictional business owners Tom and Dave. Each of them owns a building worth $1,000,000.
Scenario 1: Tom takes it in stride
Tom’s commercial property policy has an 80 percent coinsurance provision and a $5,000 deductible, and Tom purchased the required limit of insurance of $800,000. One day Tom’s business suffered a fire that caused $300,000 in damage. Because Tom had the required limit of insurance, his policy paid him $295,000 for the loss, which represents 100 percent of the cost to repair the damage, minus his deductible. That’s a scenario Tom can live with, and he was able to rebuild and move on.
Scenario 2: Dave comes up short
Dave’s commercial property policy also has an 80 percent coinsurance provision and a $5,000 deductible. But Dave decided to save some money, get less coverage, and take a chance that any loss he might suffer would be small enough to be covered. He purchased $600,000 worth of coverage. One day his business also suffered a fire that caused $300,000 in damages. But after filing his claim, he was surprised to learn that his policy wouldn’t completely cover the loss. Why? His claim payout was calculated by dividing the amount of insurance he purchased ($600,000) by the required insured amount ($800,000), or 75 percent. That percentage was then multiplied against the $300,000 loss, so the policy paid $225,000 minus Dave’s $5,000 deductible, for a total claim payout of $220,000. Dave suddenly found himself on the hook for the other $80,000 in repairs.
Which owner would you rather be after a loss? If you were in Dave’s shoes, would you be able to repair and rebuild? What if the loss was even bigger? If you suffer a loss and don’t have adequate coverage, the impact of coinsurance can be financially devastating.
How do you avoid Dave’s fate?
The only way to avoid this kind of unpleasant financial surprise is to make sure your buildings and business personal property are properly valued. Have your property inspected and appraised, consult with your insurance agent, and make sure the carrier agrees with your estimated values when the policy is issued or renewed.
Need more information on insuring your commercial property? Talk to our business insurance specialists.