Co-Insurance in Commercial Property Policy – Explained

Co-insurance in commercial property

Co-Insurance in commercial property insurance – it’s a topic that’s often misunderstood and when it is it becomes dangerous for the insured. Make a mistake here and you could be in really bad shape if a claim happens.

The first thing I want to talk about is that many business owners really don’t understand their commercial insurance – they may not ever read their policies or they never speak to their insurance broker about the coverage.

This is a mistake.

Your most valuable asset is probably your business and if it’s not insured correctly, one claim could seriously damage your personal net worth.

If you’re reading this post, I bet you have read your policy or seen a proposal and co-insurance show up and you’re wondering what it is, so good for you.

So, let’s answer the question What is co-insurance?

Co-Insurance is your insurance company’s way of encouraging you to insure your buildings and contents and business income limits to what is as accurate as its replacement value.

Why? Well, for a couple of reasons.

The first is so that your claims are settled in an accurate manner.

Underinsuring just makes a mess of any claim

The second is so that the insurance company collects a correct amount of premium to pay claims and remain solvent.

Here’s what I mean.

Say you own a masonry or non-combustible building that would cost $8 million to rebuild, but instead of insuring it for $8m you figure – what’s the worst that can happen, I’d never lost more than half of the building, so you insure it for $4 million.

Two things are going on behind the scenes here.

First, the insurance company is only collecting half of the premium they should on that building, and second, the client is taking a big gamble that they will only suffer a partial loss.

To provide some accountability and fairness to the system the insurance company may have a co-insurance clause put into the property policy of say 80% which is common in the non-standard insurance market.

By doing this, the insurer is saying that if you elect to insure the building value for less than 80% of its replacement value then you will participate in any partial claim, to the same proportion you elected to co-insure the building.

Here’s an example using the same values we just talked about. $8M building insured for $4m on a property policy with 80% co-insurance.

There’s a fire in the building that causes $2m worth of damage.

Here’s the formula used to calculate your reimbursement for the claim: Did over should times the amount of the claim.

I know that sounds a little complicated so let’s do the math.

The client DID insure the build for $4M

They Should have insured it for at least $6.4M

Now you may be thinking, shouldn’t that be $8M?

Well, ideally it should be $8M but for purposes of co-insurance the “should” is the value times the co-insurance percentage, which in this case is $8M X 80% = $6.4M

The reimbursement of the claim looks like this

4,000,000/6,400,000 = 62.5%

The amount of the loss is $2M which is multiplied by 62.5% and results in $1,250,000

This is the amount, less the policy deductible which the insurance company will pay.

So, if you had a $5,000 deductible, your insured reimbursement from this $2M claim will be $1,245,000.

That’s a shortfall of $755,000 which is going to come out of pocket.

That hopefully explains co-insurance in commercial property.

But the larger part of this discussion that I think is important to understand is that commercial property values are tremendously underinsured across the country.

Co-Insurance will make underinsurance worse, but even if you don’t have a co-insurance clause in your property policy, there’s tremendous risk in having a large or total loss and not being able to replace your property due to underinsurance.

What’s the solution?

I think the solution is working with your broker to evaluate what you own, and what it would cost to replace the property, and then evaluate the limits of coverage you have.

Need a second opinion? Want an expert involved in that process?

Why not contact me and let’s have a conversation to see if we might be a good fit for your business insurance needs?

Just a conversation to see if we’re a good fit for you and your business insurance needs.

Thanks

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