Do you have a coinsurance clause on your commercial property insurance? Do you know if the total insurable value of your property is reflected in the limit of insurance in your policy?
If you’re not sure, you could open up your business to a significant coinsurance penalty.
What is Coinsurance?
Most commercial property policies include a coinsurance clause and, particularly in that case, it is critical that you accurately insure according to the replacement value. If not, your company may be responsible for being the “co-insurer,” picking up the costs not covered in the policy because it was inaccurately valued in the insurance policy.
Coinsurance in Practice
If the Total Insurable Value of a property is $500,000 and the policy carries an 80% coinsurance requirement, then the minimum amount of insurance that must be carried if a business wants partial losses to be completely covered (less the deductible) is $400,000. For example, in these conditions a $20,000 loss (assuming all other conditions of the policy are satisfied) would be fully paid, minus the deductible.
However, if a business misidentifies the Total Insurable Value, insuring for less than the 80% required by the policy, the partial losses may not receive full payment.
If the $500,000 property described above were only insured for $250,000, violating the 80% coinsurance requirement, the payment for that same claim may be only be covered at half the rate described above, minus the deductible.
In this second scenario, the business becomes a “co-insurer,” paying out of pocket for the portion not covered. In other words, while you may believe that you will be paid $19,500 for your $20,000 claim, considering a $500 deductible, you might only receive $9,500. That is the coinsurance penalty.
Of course, determining the proper amount is tricky because it must match at the time of the loss in order to avoid the coinsurance penalty, making frequent insurance reviews important to keeping the limit of insurance updated.
Only insuring at 80% may meet the requirements for a partial loss, but in the case of an entire loss, the property is underinsured by $100,000 and the insured would need to pay that out of pocket. It might be tempting for a business to insure for a lesser amount in anticipation that a partial loss of their insured building and property is more likely than a total loss but that is a big risk to take.
Protecting Your Business
There are a couple of steps you can take to make sure that your business is not positioned to experience this penalty. First, if you have a coinsurance clause, make sure your policy reflects updated information about the replacement cost of your commercial building. Be careful not to confuse this figure with market value. Remember to review your limit of insurance frequently as changing values can influence your compliance with the coinsurance clause. Second, consider adding an Agreed Value endorsement. It would replace the coinsurance clause, considering only the agreed value for your property when responding to any claims.
Most importantly, as you consider the intricacies of your policies for your business, work with an insurance professional that you trust. At Compass Insurance Partners, we would be happy to assist you in getting the coverage that best fits your business.