Your new Commercial Property Policy has a $600,000 limit for Building coverage, written on a Replacement Cost basis, with 80% coinsurance. What exactly does that mean?
Coinsurance is a way to ensure that those buying property coverage buy an amount that reflects the value of the property. In this case, “value” means the cost to rebuild the building. The market value of the property isn’t relevant because that value includes the land on which the building sits and is determined by the real estate market rather than by construction prices.
Let’s say that your building will cost $1,000,000 to replace should it be destroyed in a fire or a hurricane. This $1,000,000 is the insurable “value” of your property. Now you have to make a decision. Do you want to insure the full value, or take a chance that you won’t have a total loss? Many property owners choose to insure only 80% or 90% of the value of the property in order to save on premium, and this is allowable under most Property Policies. If insuring to 80%, the required limit is $800,000. If insuring to 90%, the required limit is $900,000. This percentage is called the coinsurance percentage.
In the example above, because the building with a $1,000,000 replacement cost is insured at 80% coinsurance, the property owner is required to carry $800,000 coverage. The policy limit is only $600,000, though. So what happens if there is damage to the building? If a fire were to cause $400,000 damage, the property owner would likely expect to be paid the full $400,000, minus any deductible, because the damage is less than the $600,000 policy limit.
Because the property owner didn’t buy the $800,000 coverage required, though, there will be a coinsurance penalty applied at the time of the claim. The $600,000 limit is 75% of the $800,000 limit required. Because the property owner bought only 75% of the limit he should have purchased, he will collect only 75% of the amount of his claim, in this case $300,000, less the policy deductible.
It’s the rare person that isn’t looking for a way to save dollars on his insurance premium. Not buying the required amount of coverage, though, isn’t a smart way to save money. Discuss the valuation of your property with your insurance advisor so that you understand what the policy requires and what the penalties are if you don’t comply.