A friend called me a few days ago whose store (a building material dealer) had just burned to the ground in an accidental fire. He was concerned that he would not receive enough payment from his insurance company to cover the cost to rebuild and refurnish his store. The reason for his concern was that he knew he had a 90% coinsurance clause on his policy and he had reason to believe that the valuation of his store (pre-loss) would greatly exceed the amount of coverage he purchased.
After listening to my friend and asking a few questions, I realized that his replacement cost was $2.3 million and he had only purchased $1.6 of coverage. I became the bearer of bad news (well, really just confirming what he already knew) since with a 90% coinsurance clause, he needed to purchase at least $2.07 million to avoid the coinsurance penalty. In fact, any partial loss of his property would have only been covered at 77% of the loss amount ($1.6 / $2.07) less the deductible. I told him that coinsurance clauses are put in place to provide incentive to insureds to purchase proper limits. Since most property losses are small and the policy limits aren’t reached, without a coinsurance clause the insurer would be paying for losses without having collected the appropriate amount of coverage for the full exposure.
There are several variations as to how coinsurance clauses apply and often times an insurer is willing to provide coverage with no coinsurance clause. However, when there is no coinsurance clause, it is very important to the insurer to properly value the property and there are often disagreements between parties. Insureds and Insurers should work together in good faith to properly value property and further to insure to those values. In the long run it is good for all, but in particular an insured whose policy has a coinsurance clause needs to make sure they purchase proper limits.