Property Insurance: What in the World is Coinsurance?

Virtually all insurance companies require that property owners insure their property for a minimum amount of coverage. Most often that amount is at least 80 percent of the replacement value of the property. For example, if the property can be replaced for $100,000, the property owner must buy at least $80,000 worth of insurance. If all policyholders buy the required minimum amount of coverage, the company will collect enough premiums to pay losses and make a profit. This requirement is called the “coinsurance requirement.” Policy holders must adhere to this requirement in order for losses to be paid without problem under the terms of the policy.

Coinsurance is critical because experience has shown that if less than 80 percent of the replacement value is covered, the insurance companies would not collect enough money to pay all of the claims that clients are due when disaster strikes. Since most property claims are small, some owners might figure they only need a small amount of coverage to pay for the claims that might need to be made. Some property owners might want to buy only 10 percent of the value of the property to be insured. That amount would pay for most small claims, like broken windows or water leaks, but never the full amount if a property suffers significant destruction or damage.

Think of it this way, it’s just like going out to dinner with a large group of people and having one bill for the entire group.  At the end of the evening when the bill comes, everyone agrees to contribute a sufficient amount of money to cover the charges. If only some people contribute their share of the bill, there won’t be enough money to pay for the dinner. Insurance operates the same way. Insurance companies estimate what their claims and expenses will be in the short-term future, and using this information, calculate the amount policyholders should pay to cover the claims and expenses and keep the insurance company in business. If some of the policyholders don’t buy a sufficient amount of coverage, the necessary amount of money to cover all claims that might arise just won’t be there when the time comes.

THE COINSURANCE PENALTY

What happens if a property owner does not buy the sufficient amount of coverage, (less than 80 percent) and suffers major property damage? If that were to occur, the owner would be assessed a “coinsurance penalty,” and would not get paid the full amount of a property loss. Only part of the loss would be paid to the property owner because only part of the insurance was purchased. For example, if he or she needed 80 percent or $80,000 of coverage, but only bought $40,000, or 50 percent of the necessary coverage, only half of the amount of the loss would be paid out by the insurance company because that’s all the coverage that was purchased. If the loss were $10,000, only $5,000 would be paid. This is the coinsurance penalty. The property owner is being “penalized” because he or she purchased only half of the required coverage. If a property owner buys the proper amount of coverage, all of their property claims are paid in full up to the limit of coverage. If he or she has a $5,000 loss, $5,000 is paid (after the deductible is met).

Coinsurance is not the only issue you need to be aware of when reviewing property insurance policies. Individuals sometimes underinsure their property to save money on premiums. We all want to save money. But insurance buyers should be aware that this may actually end up costing more money if a loss occurs.  As one of our members recently remarked, “Insurance is spending money daily so it doesn’t cost us more down the road.”

For more information regarding insurance questions or if you are interested in getting a quote on any of your business operations, contact Greg Nelson at Western Growers Insurance Services, (949) 885-2287 or gnelson@wga.com.