Understanding Coinsurance with Commercial Property Examples
John Burkhalter, CRIS, RCIP
Insurance Advisor at Higginbotham | Enterprise Risk Management
In the realm of commercial property insurance, mastering the intricacies of your policy is crucial for safeguarding your substantial investments. One term that holds significant sway in your insurance coverage is "coinsurance." While it may sound technical, comprehending this concept is paramount for securing your financial future. Below is a scenario that underscores the importance of coinsurance and how to better protect your investments.
Setting the Stage
You buy a commercial property at a replacement cost value of 5 million in 2022. In 2023, prior to your renewal, you notice your building that originally cost 5M to replace, NOW would cost you 10M to replace due to materials, labor, market conditions, etc. On the surface, you believe you are still covered for you "full building amount" coverage. However, when you go through 50-100 pages of your policy you glance over a seemingly small "coinsurance clause" within your policy.
The Coinsurance Clause
Despite being tucked away in the fine print of your policy, the coinsurance clause serves as the cornerstone of your insurance policy. It mandates that your property must be insured for a predetermined percentage of its total value. In this instance, the coinsurance requirement stands at 80%. Consequently, for your CURRENTLY VALUED 10M property, you are NOW obligated to maintain coverage of at least $8 million (80% of $10 million).
The Scenario
Now, let's envision a scenario where a catastrophic event unfolds, resulting in the total loss of your property. As discussed, the replacement cost value of your building is NOW 10M. However, bear in mind that your policy is only set to cover $5 million, which falls significantly short of the required $8 million stipulated by the coinsurance clause.
Calculating Your Payout
In this instance, AT THE TIME OF LOSS, the cost to rebuild your entire building is determined to be 10M. In 2022, you purchased insurance on 5M of replacement cost value, but that value is now double what it was.
(Purchased Insurance Amount / Required Insurance Amount) x Loss = Payout
In your case, this translates to:
($5 million / $8 million) x $10 million (Total Loss) = Payout
Consequently, your payout would be:
($0.625) x $10 million = $6.25 million
In most cases, the underwriter could even limit payout to the full policy limit from 2022 which is 5 million.
The Takeaway
In the event of a total loss, with your property insured for $5 million while the requirement under the 80% coinsurance clause is $8 million, your insurance payout would amount to $6.25 million. This implies that you would be responsible for covering the remaining $3.75 million from your own resources, shedding light on the financial risks associated with underinsurance when dealing with such substantial property values.
This scenario emphasizes the imperative nature of comprehending coinsurance and ensuring that your coverage aligns with the coinsurance clause specified in your policy. Adequate coverage is not only a shield for your investments but also a means of mitigating the peril of bearing significant financial burdens when confronted with unforeseen circumstances.
As a vigilant and forward-thinking commercial property owner, it is essential to engage with a seasoned insurance professional who can guide you through the nuances of coinsurance and custom tailor a policy to precisely match your unique needs. This approach fortifies your financial security in the face of unexpected events, ultimately safeguarding your valuable investments.
By: John Burkhalter, AINS, AU, CRIS, RCIP
[email protected] or 720-926-2146
Sources: