When it comes to property coverage, there can be a clause in the policy called coinsurance, which is seen in business insurance policies to help an insured maintain coverage to value. An insurance policy is a promise of utmost good faith – the insured should believe that the provider will keep its promise to properly insure their client, in return for the premium the insured pays to keep the policy in force. That being said, the insurance company must trust that the insured is being truthful on the policy application(s) with the coverage and limit information provided, which is the basis for the premium amount.
If an insured has falsified info on their application, consequences can result. Depending on the incorrect info, the insurance company could cancel the policy. In the case of inadequate property values, the policy probably will not be canceled, but the insured will be penalized for being underinsured at the time of a loss. This is where the percentage of coinsurance comes into play.
When a tanning salon’s policy is written on a Replacement Cost basis (which is the preferred form), the operator must look at everything inside the facility, including improvements to the space, stock, equipment and items that the landlord requires in the lease. Calculate what it would cost to replace all those items, NEW, in today’s market. The coinsurance limit determines how much of that total replacement cost is needed for an adequate property limit – the higher the percentage, the higher the limit. Simply
Simple Coinsurance Formula:
stated, 80 percent coinsurance means that only 80 percent of the replacement cost is needed to be valued in order to avoid penalty. A policy with 100 percent coinsurance requires that the info provided to the insurance company represent 100 percent of the property value in order to avoid penalty.
Here is an example that shows the difference between 80 percent coinsurance and 100 percent coinsurance, and how a 20 percent swing can be the difference in vital coverage.
100% Coinsurance:
Property Replacement Value = $100,000
Limit Carried: $80,000
Deductible: $1,000
Amount of the Loss = $50,000
Step 1) $100,000 x 100% coinsurance = $100,000 (the minimum amount required)
Step 2) $80,000/$100,000 = .80
Step 3) $50,000 x .80 = $40,000
Step 4) $40,000 – $1,000 = $39,000
In this instance, even though you suffered a $50,000 loss, the insurance company will not pay more than $39,000 because you are underinsured and will incur a coinsurance penalty.
This example easily explains why 100 percent isn’t always the best option. Keep these terms in mind when you are choosing an insurance provider.
