How Does Coinsurance Work on Commercial Property?

Commercial property insurance protects businesses from financial losses due to damage to their physical assets. These policies often contain a “coinsurance clause,” a provision that influences how claims are paid. This article explains the mechanics of coinsurance, detailing its purpose, calculation, and strategies for compliance.

Fundamentals of Commercial Property Coinsurance

Coinsurance in commercial property insurance requires policyholders to insure their property for a specified percentage of its total value, typically ranging from 80% to 100%. This encourages businesses to maintain coverage that closely reflects the property’s actual replacement cost or actual cash value. The primary purpose is to prevent underinsurance, ensuring policyholders carry sufficient coverage rather than opting for lower limits to reduce premiums.

Coinsurance differs from a deductible. A deductible is a fixed amount the policyholder pays out-of-pocket before the insurance company covers a claim. Coinsurance is not an upfront payment; instead, it is a percentage clause that affects the amount an insurer pays for a partial loss if the property is underinsured at the time of the loss. If the insured value falls below the required percentage, a penalty reduces the payout, even if the loss is within the policy’s overall limit.

Calculating Coinsurance Penalties

When a commercial property experiences a loss with a coinsurance clause, the insurer assesses if the property was insured to the required percentage of its value at the time of the incident. If the amount of insurance carried is less than required, a penalty reduces the claim payout. The standard formula for calculating the payout after a coinsurance penalty is: (Amount of Insurance Carried / Amount of Insurance Required) x Amount of Loss = Amount of Recovery. The “Amount of Insurance Required” is determined by multiplying the property’s value at the time of loss by the coinsurance percentage specified in the policy.

Consider a commercial building valued at $1,000,000 with an 80% coinsurance clause, meaning $800,000 in coverage is required. If the business had purchased $800,000 in coverage and suffered a $50,000 loss (with a $1,000 deductible), the insurance company would pay $49,000 ($50,000 – $1,000). In this scenario, the coinsurance requirement was met, and no penalty was applied.

However, if the same $1,000,000 building with an 80% coinsurance clause was only insured for $600,000, it would be underinsured by $200,000 ($800,000 required – $600,000 carried). If a $50,000 loss occurred, after a $1,000 deductible, the initial payout would be $49,000. Applying the coinsurance formula: ($600,000 Carried / $800,000 Required) x $49,000 (Loss – Deductible) = $36,750. In this case, the business would only receive $36,750, leaving a significant portion of the loss to be covered out-of-pocket due to the underinsurance penalty.

Strategies for Meeting Coinsurance Requirements

To avoid coinsurance penalties, commercial property owners should proactively manage their insurance coverage. Regularly reviewing and updating property valuations is an important step, especially given factors such as inflation, rising construction costs, and property renovations. Property values can change significantly over time, and an outdated valuation can lead to underinsurance even if the initial coverage seemed adequate. Insurers typically base the property’s value on an appraisal conducted at the time of a loss, not necessarily on figures provided during policy inception.

Consulting with an insurance agent or a qualified appraiser is highly advisable to determine the appropriate insured value. These professionals can assist in conducting accurate insurance-to-value (ITV) calculations, which aim to approximate the full cost to replace or restore the insured property. Businesses should ensure their coverage reflects the replacement cost, not just the market value, as rebuilding costs can differ significantly from what a property might sell for. Failing to meet the coinsurance clause can result in a reduced payout, forcing the business to bear a larger portion of the financial burden for a covered loss.