What it means
Most property policies contain a coinsurance clause, typically set at 80%, 90% or 100% of the property's insurable value. The clause says the owner must carry cover of at least that percentage of value, and if they do not, the insurer applies a penalty to any partial claim.
The logic is about pricing fairness rather than punishment. Small and medium losses are far more common than total losses, so an owner who insures a $1,000,000 building for $500,000 is buying most of the practical protection for half the premium, and the coinsurance clause removes that advantage.
Applying the formula requires knowing the property's value at the time of loss, not at the time the policy was written. This is where owners get caught, because construction costs and property values drift upwards while the sum insured sits unchanged in a filing cabinet for years.
Two protections exist for careful owners. An agreed value endorsement suspends the coinsurance clause in exchange for an up-front valuation the insurer accepts, and an inflation guard automatically raises the sum insured each year to keep pace with rebuilding costs.
The same word means something quite different in health insurance, where coinsurance is simply the share of a medical bill the patient pays after the deductible, such as 20% of costs. Both uses involve the insured party carrying part of the risk, but only the property version involves the proportional penalty formula described here.
In practice
Real-world examples.
Example
A restaurant group insures a $600,000 fit-out for $360,000 under a 90% coinsurance clause. A kitchen fire causing $90,000 of damage is settled at only two thirds of the loss, because $360,000 divided by the required $540,000 is 0.667.
Example
A landlord who has not revalued a warehouse in eight years discovers at claim time that rebuilding costs have risen 40%, which pushes his sum insured below the 80% requirement even though it was adequate when the policy was written.
Example
A manufacturer buys an agreed value endorsement after a professional valuation, which removes the coinsurance clause for the policy year. When a partial loss occurs, the insurer pays the full amount less the deductible with no proportional reduction applied.
Formula
Calculation
Claim payment = (insurance carried / (coinsurance percentage x property value)) x loss, then subtract the deductible. The payment can never exceed the policy limit or the actual loss.
A warehouse has an insurable value of $1,000,000 at the time of the fire, and the policy carries an 80% coinsurance clause, so the required amount of insurance is $1,000,000 x 0.80 = $800,000. The owner had only $600,000 of cover in place, and the deductible is $10,000. A fire causes $200,000 of damage.
The coinsurance ratio is $600,000 / $800,000 = 0.75. Applying it to the loss gives 0.75 x $200,000 = $150,000, and subtracting the deductible leaves $150,000 - $10,000 = $140,000 paid by the insurer. The owner absorbs $200,000 - $140,000 = $60,000, made up of the $10,000 deductible and a $50,000 coinsurance penalty.
Had the owner carried the required $800,000, the ratio would have been 1.00 and the insurer would have paid the full loss less the deductible: $200,000 - $10,000 = $190,000. The difference between the two outcomes is $190,000 - $140,000 = $50,000, which is the direct cost of being under-insured on a single moderate claim.Case study
Seen in the real world.
This illustrative case involves a fictional company. Drenmore Packaging owned a distribution warehouse it had insured for $600,000 since the building was bought. The finance director knew rebuilding costs had climbed but had not requested a revaluation, partly because raising the sum insured would have raised the premium in a year when costs were already under pressure.
A fire in the dispatch bay caused $200,000 of damage. The loss adjuster valued the building at $1,000,000 at the date of loss, which meant the 80% clause required $800,000 of cover against the $600,000 actually carried. The claim was settled at 0.75 x $200,000 = $150,000, less the $10,000 deductible, for a payment of $140,000.
Drenmore therefore funded $60,000 of a $200,000 loss out of its own cash, of which $50,000 was purely the coinsurance penalty. In this fictional account the company added an annual valuation to its insurance renewal checklist and bought an inflation guard endorsement, at an extra premium far below the penalty a single moderate claim had already cost it.
Watch out
Common mistakes.
- Believing the coinsurance penalty only applies to total losses, when it bites hardest on the partial claims that make up most real-world insurance events.
- Comparing the sum insured with the price originally paid for the property rather than its rebuilding value at the date of loss, which is the figure the formula actually uses.
- Confusing property coinsurance with health insurance coinsurance, which is simply a percentage of a bill the patient pays and involves no proportional penalty.
Questions
People also ask.
What coinsurance percentage is typical?
Commercial property policies most often use 80%, though 90% and 100% clauses exist and generally carry a lower premium rate in exchange for the stricter requirement.
How can a business avoid a coinsurance penalty altogether?
Either revalue the property regularly and keep the sum insured above the required percentage, or buy an agreed value endorsement that suspends the clause for the policy period.
Does the deductible come off before or after the coinsurance calculation?
The proportional reduction is applied to the loss first, and the deductible is then subtracted from that reduced figure, which is why the two costs stack up.
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