Understanding Your Exposure with Coinsurance

By Craig Frank, NAI Norwood Group cfrank@nainorwoodgroup.com

In today’s economy, everyone is managing risk more than they have in the past. Commercial real estate is no different. Insurance is a huge portion of risk management that property owners and investors have to manage. However rather than looking at insurance as a common area expense that is paid out of cash flow, lets analyze it from the stand point of what happens when a loss occurs.

Understanding a Coinsurance Clause
Coinsurance is an insurance policy stipulation that a building, personal property or business income including loss of rents be insured for at least a certain percentage of its insurable value. Failure by the Insured to adequately carry the required amount of insurance will result in the Insured becoming a Coinsurer in the loss. We will focus on Building and typical Coinsurance percentages are 80, 90 or 100%. There are several different methods by which an insurance company may “value” the amount it will pay for a loss such as Replacement Cost (RC) or Actual Cash Value (ACV). For our discussion we will assume RC, so this valuation compensates the Insured for the actual cost to replace or rebuild the property with comparable material and
quality.

Loss Example
Replacement Cost of Building: $2,000,000
Coinsurance: 80%
Amount of Insurance Required: $1,600,000 (2,000,000 x .80)
Amount of Insurance Carried: $1,000,000
Loss: $400,000
Deductible: $5,000

Calculating the Loss Paid by Insurance
The insured is only going to get a fraction of this loss covered by their insurance company because of the co-insurance clause.

Amount of Insurance Carried: X Insurable Loss - Deductible = Amount of Loss Paid by Insurance
Amount of Insurance Required

$1,000,000 X $400,000 - $5,000 = Amount Paid by Insurance
$1,600,000

.63 X $400,000 - $5,000 = $247,000 (Amount Paid by Insurance)

One can see that it is important to understand how the Coinsurance Clause within the insurance policy functions. In this example the Insured was underinsured for the minimum requirement of the Coinsurance Clause by $600,000. As a result the Insurance Company will pay $247,000 of loss and the Insured will become a Coinsurer and pay $153,000. Had the Insured carried a limit of $1,600,000 (Amount required to meet the 80% Coinsurance Provision) the loss would have been paid in full, less the deductible by the Insurance Company.