Co-insurance is one of most commonly misunderstood and confusing concepts in insurance. At Thor, we want to help you understand what co-insurance is, how it works and how you can use it to your advantage.
What is co-insurance?
Co-insurance is a clause used by insurance companies on policies covering property such as buildings, contents, stock or industrial equipment. This clause makes sure policy holders insure their property to an appropriate value and that the insurer receives a fair premium for the risk—whether on a replacement cost basis or on an actual cash value basis (subject to depreciation). The co-insurance clause can also be found on business interruption policies where it ensures that policy holders insure their revenue stream to an appropriate value.
How does co-insurance work?
Generally, co-insurance is expressed as a percentage. The most common clauses require policy holders to insure to 80%, 90% or 100% of the true value. For instance, a building valued at $1,000,000 replacement value with a co-insurance clause of 90% must be insured for no less than $900,000. The same building with an 80% co-insurance clause must be insured for no less than $800,000.
What if I choose to insure for less than the amount required by the co-insurance clause?
If a property owner chooses to insure for less than the amount required by the co-insurance clause, the property owner is essentially agreeing to retain part of the risk rather than transfer it to the insurance company. The owner thus becomes a ‘co-insurer’ and will share the loss with the insurance company.
Here is an example that demonstrate how the clause works:
Building value – $1,000,000
Co-insurance requirement – 90%
Required amount of insurance – $900,000
Actual amount of insurance – $600,000
Amount of loss – $300,000
The co-insurance formula is:
Actual amount of insurance X Amount of loss
__________________________________________________________________ = Amount of claim
Required amount of insurance
Inserting the above amounts in the formula produces the following calculation:
$600,000 X $300,000
______________________________________ = $200,000
The owner absorbs a $100,000 co-insurance penalty. Since they chose to retain one third of the risk rather than transfer it to the insurer, they absorb one third of the loss. If the building had been insured to the amount required by the 90% co-insurance clause, then the co-insurance calculation would look like this:
If you have any questions about co-insurance or anything else, please get in touch. We’re always here when you need us.