Understanding Coinsurance Clauses

Coinsurance clauses are increasingly common in commercial property policies. In this blog, we explain what coinsurance is, why it exists, and how you can avoid penalties for being underinsured.

What is a Coinsurance Clause? 

Coinsurance is a common clause in commercial property insurance that requires you to insure your property for a specific percentage—typically 80-90%—of its total value. If you don’t meet this requirement and need to file a claim, you could face a coinsurance penalty, meaning your payout may be reduced.

This rule is in place to prevent property owners from underinsuring their buildings to save on premiums while still expecting full coverage in a loss. While often found in commercial policies, coinsurance clauses are rarely apply to personal policies like homeowners insurance.

Coinsurance Clause Required Coverage Example

Let’s say your commercial building is valued at $1,000,000, and your policy has an 80% coinsurance requirement. This means you must insure the building for at least $800,000 (80% of its value) to receive full coverage in a claim.

If you insure it for less than $800,000, your insurance payout may be reduced, and you could be responsible for covering part of the repair costs yourself.

What are the Penalties for Not Meeting the Coinsurance Clause?

A coinsurance penalty applies if you fail to insure your property up to the required percentage stated in your policy (typically 80% or 90%). Instead of receiving full coverage, your claim payout will be reduced proportionally, meaning you’ll have to cover part of the loss out of pocket.

However, if you insure your property for at least the required amount or more, no penalty applies.

The penalty is calculated using this formula:

(Actual coverage amount ÷ Required coverage amount) × Loss amount = Adjusted payout

This ensures that underinsuring your property results in a partial payout, leaving you responsible for the remaining costs.

Coinsurance Clause Penalty Example

Imagine you own a commercial building valued at $1,000,000 and your policy includes an 80% coinsurance clause. To avoid penalties, you should insure the building for at least $800,000. However, you choose to insure it for only $700,000.

Now, let’s say a fire damages part of your building, resulting in $200,000 in repair costs. Because you underinsured your property, your insurance company will reduce your payout using the coinsurance penalty formula.

(Actual coverage amount ÷ Required coverage amount) × Loss amount = Adjusted payout

In this case:

($700,000 ÷ $800,000) × $200,000 = $175,000

This means your insurance company will only pay $175,000, leaving you responsible for the remaining $25,000.

By ensuring your property is insured for at least the required amount, you can avoid penalties and receive full coverage in the event of a loss.

Now, let’s say everything else remains the same, but you purchase an insurance policy with $800,001 in coverage. Since this amount exceeds the 80% requirement ($800,000), your insurance company will fully cover the $200,000 loss.

Disclaimer: Coverage is subject to the terms, conditions, and exclusions of your policy. Other policy clauses or violations may affect the final payout.

How Do I Know I Have Enough Coverage?

Ensuring you have the right amount of insurance is crucial to avoiding penalties under the coinsurance clause. However, it’s important to understand that insurance coverage is not based on market value—the price someone would pay to buy the property.

Market value includes factors like supply and demand, land costs, location perks (such as a view or high-traffic area), which do not reflect the actual cost of rebuilding your structure after a loss.

Instead, insurance companies use specialized replacement cost calculators to determine the appropriate coverage amount. To make sure your coverage is accurate, you should:

• Double-check your property details (year built, square footage, upgrades)

• Request a cost guide valuation to confirm your building’s features are correctly listed

• Update your agent on any renovations or improvements to prevent  miscalculations

How is Property Value Calculated for Insurance?

Insurance companies use special tools to estimate the cost of rebuilding or replacing a property. These tools consider factors like:

• Square footage

• Year the building was constructed

• Attached features such as decks and garages

• Roof and siding materials

• Current construction costs

There are two ways to calculate a building’s value:

1. Replacement Cost (RC): The cost to rebuild with new materials.

2. Actual Cash Value (ACV): Replacement cost minus depreciation for age and wear.

   
   

Over time, replacement costs tend to rise due to inflation and material price increases, while actual cash value decreases as the building ages.

While standard homeowners insurance typically defaults to replacement cost, commercial property insurance may use either replacement cost or actual cash value. Reviewing your policy will help you understand which valuation applies to your building.

If you're unsure whether you have adequate coverage, reach out to your insurance agent for a policy review.

Avoid Penalties and Protect Your Property

Understanding coinsurance clauses is essential to ensuring your commercial property is properly insured and avoiding unexpected penalties. By maintaining the right coverage amount and reviewing your policy regularly, you can protect your business from costly coverage gaps.

If you're unsure whether your policy meets coinsurance requirements or need expert guidance on selecting the right coverage, Hillock Insurance is here to help. Contact us today for a commercial insurance review and a personalized quote to ensure your business stays fully protected.