What Is the Coinsurance Formula?
The coinsurance formula is thehomeowners insurance formula that determines the amount of reimbursem*nt that a homeowner will receive from a claim. The coinsurance formula becomes effective when a homeowner fails to maintain coverage of at least 80%of the home's replacement value. Those who file a claim in this situation will only receive partial reimbursem*nt according to the formula.
Key Takeaways
- The coinsurance formula determines the reimbursem*nt amount that a homeowner or property owner will receive from a claim.
- The coinsurance formula is applied when a property owner fails to maintain coverage of at least 80%of the home's replacement value.
- If a property ownerinsures for less than the amountrequired by the coinsurance clause, they essentially agree to retain part of the risk.
- In this case, the owner becomesa "co-insurer"and will share any loss with the insurance company according to the coinsurance formula.
How the Coinsurance Formula Works
Coinsurance is a clause used in insurance contracts on property insurance policiessuch as homeowners insurance. The clause ensurespolicyholders insure their property to an appropriate value and that the insurer receives a fair premium for the risk. If you have an outstanding mortgage loan on the property, your mortgage lender will likely require you to have a minimum amount of coverage.
Coinsurance is usually expressed as a percentage. Most coinsuranceclauses require policyholders to insure 80%, 90%, or 100%of a property's actual value. For instance, a building valued at $1,000,000 replacement value with a coinsurance clause of 90%must be insured for no less than $900,000. The same building with an 80%coinsurance clause must be insured for no less than $800,000.
The coinsurance formula is relatively straightforward. Begin by dividing the actual amount of coverage on the house by the amount that should have been carried (80% of the replacement value). Then, multiply the result by the amount of the loss, which will give you the reimbursem*nt amount.
If a property ownerinsures a property for less than the amountrequired by the coinsurance clause, they becomea "co-insurer"and will share the loss with the insurance company.
Examples of the Coinsurance Formula
If a property ownerinsures for less than the amountrequired by the coinsurance clause, they are essentially agreeing to retain part of the risk. Thus, they becomea "co-insurer"and share any losses with the insurance company according to the coinsurance formula.
Here are two examples that demonstrate how the coinsuranceclause works.
Example 1: Inadequate Amount of Coverage
Building Value: $1,000,000
Coinsurance Requirement: 80%
Required Amount of Insurance: $800,000
Actual Amount of Insurance: $600,000
Amount of Loss or Cost of Repairs: $300,000
The coinsurance formula is:
(Actual amount of insurance/Required amount of insurance) X amount of loss = Amount of claim paid by the insurer
Based on the amounts above, the formula produces the following:
- ($600,000 actual coverage / $800,000 required coverage)=0.75 or 75% of the required minimum coverage
- 0.75 X $300,000 in damages = $225,000 paid by the insurer for the claim
The insurance company will pay $225,000 of the claim despite $300,000 worth of damage. The owner absorbs a $75,000 coinsurance penalty since they did not buy enough coverage. Therefore, the ownerpays out of pocket for 25% of the loss.
Even though the owner had more than enough coverage to cover the claim amount—$600,000 in coverage for a $300,000 claim—the owner was underinsured. The owner had only 75% of the required minimum coverage of $800,000. As a result, the insurer only paid 75% of the claim amount.
Example 2: Adequate Amount of Coverage
If the building had been insured to the amount required by thecoinsurance clause (in this case, 80%),the coinsurance calculation would look like this:
Building Value: $1,000,000
Coinsurance Requirement: 80%
Required Amount of Insurance: $800,000
Actual Amount of Insurance: $800,000
Amount of Loss or Cost of Repairs: $300,000
Here's the formula again:
- (Actual amount of insurance/Required amount of insurance) X amount of loss = Amount of claim paid by the insurer
And here's the calculation:
- ($800,000 actual coverage /$800,000 required coverage) = 1; required coverage satisfied
- 1 X $300,000 in losses = $300,000 paid by the insurer
In the second example, the owner met the coinsurance requirement and did not need to pay anything out of pocket. In other words, the insurer will pay the total amount of the $300,000 claim without penalty to the owner.
Monitor Your Coverage
These examples illustrate why it's important to maintain enough insurance coverage to match the percentage of the property value required by the insurer. If the property value increased by 20% to $1,250,000, the 800,000 in coverage would no longer be adequate because it would represent 64% of the property value ($800,000 / $1,250,000) and not 80% required by the insurer.
It's also important to know how much of a deductible you are responsible for in your policy. The examples above assumed no deductible. If there was a deductible, the deductible amount would reduce the insurance company's claim payment, and the owner would be responsible for paying that amount out of pocket. Coinsurance clauses are also found in business interruption policies. These clauses ensure that policyholders insure their revenue stream to an appropriate value.
What Does 80% Coinsurance Mean for Homeowners?
Many insurance companies require property owners to buy a minimum amount of coverage. Typically, insurers require at least 80% of the property's replacement value in coverage. If the homeowner buys an inadequate amount of insurance, the insurer may not cover 100% of the claim amount.
How Do You Calculate Coinsurance on a Property?
To calculate the coinsurance penalty, divide the amount of current insurance coverage by the required insurance amount and multiply that result by the loss or cost to repair the property. The required insurance amount should be stated in your policy and is often expressed as a percentage of the property value, such as 80%.
What Coverage Limit Should I Buy for My Home?
If you buy a home, check with your mortgage lender and the required homeowners insurance coverage. Many insurers require at least 80% of the replacement value of the property, but some policies require 90% or 100%.
The Bottom Line
The coinsurance formula determines the amount of reimbursem*nt that a homeowner or property owner will receive from a claim. Homeowners are required to have a minimum amount of coverage when they buy a homeowners insurance policy, which is typically 80% of the property's replacement value. The coinsurance formula is applied when a property owner fails to maintain the minimum coverage. As a result, the owner will be responsible for a percentage of the loss out of pocket.
