Originally published in Comments - Spring 2012
The terms and conditions of a property insurance policy remain a mystery to many. One of the critical aspects of an insurance policy is the co-insurance clause. If present, it affects the amount payable in the event of a partial or total loss.
In broad terms, co-insurance under a property policy is defined as the "sharing of risk between an insurer and the insured. normally expressed as a percentage."1 If a policy is subject to a co-insurance requirement, this means that the policy owner must satisfy the specified criteria in the event of a loss claim. Most claims are for partial loss only; therefore, insuring for less than 100% of the asset value may be advantageous in reducing annual premiums. However, be forewarned: in the event of a total loss, insuring 100% of the asset value is the only means to get full loss compensation (less the applicable deductible). Otherwise, the policy limit will apply.
A simple example of calculating the requirement for property coverage, with a lower co-insurance amount is as follows:
Your property is currently valued (building and all contents) at $900,000 at replacement value; and
Your co-insurance requirement is stipulated to be 80% of the replacement value.
Based on the above, you are required to insure your property and pay corresponding premiums for at least $720,000 in replacement coverage. This would allow for full compensation on losses claimed (up to the limits of the policy).
The obvious question is – what happens if I insure for less than this amount?
The answer is that you will face a co-insurance penalty. The following formula illustrates a scenario when the co-insurance
requirement is not met. In this case, your insurer will only pay the percentage of your total loss up to the value of your insurance coverage.
Using the same example, assume you purchased $650,000 of building and contents insurance and you suffered a partial loss of property. Damages will cost $300,000 in repairs and you have a $1,000 deductible. Your insurer will calculate the amount that they owe you as follows:
$650,000 insurance carried over $720,000 insurance required (as calculated above) = 90.3% loss reimbursement.
90.3% x $300,000 loss claimed minus $1,000 deductible = $269,900 payable by the insurance company.
Therefore, you personally pay for $29,100 of your $300,000 partial loss claim because your policy did not carry sufficient insurance (plus your $1,000 deductible).
Now, if you purchase the insurance required and suffer a $300,000 loss, you satisfy the co-insurance clause of having at least 80% coverage on the $900,000 value of your insured property. Therefore, your only financial responsibility is the $1,000 deductible.
Understanding the impact of insufficient insurance coverage is invaluable in setting the right terms for your policy and avoiding costly penalties should you need to make a claim. The level at which you should insure your assets is a decision between you and your insurance broker. Your accountant can assist by providing important information on decisions relating to your insurance needs.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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