Coinsurance: The Property Insurance Version of a 4-Letter Word

Coinsurance provisions found in property policies exist primarily to assure that the insurance carrier receives adequate premium for the property insured. Without a coinsurance condition, and its applicable penalties, insureds might be willing to purchase an amount of coverage somewhat less than the value of the subject property – because of the statistically low probability of a total loss. The purchase of lower limits cuts the collectable premium which ultimately necessitates higher rates (a price/rate spiral that ultimately results in the lack of available property insurance).

“Maximum” Losses

Property is subject to two types of loss “maximums” which can lead to the discrepancy between insurable value and the insurance carried as alluded to in the first paragraph: 1) Maximum Possible Loss (MPL); and 2) Probable Maximum Loss (PML). The key terms are “possible” and “probable.”

It is “possible” that the entire structure may be destroyed in any one loss; thus the MPL is the entire value of the structure – the Total Insurable Value (TIV). However, a partial loss is statistically more likely than a total loss, thus the amount of the expected loss is considered the structure’s “probable” loss. Insureds with the greatest difference between the PML and MPL, lacking the coinsurance provision, might only purchase enough property protection to cover its probable maximum loss (PML).

In the late 1800’s to early 1900’s the insurance industry realized this potential (some carriers may have even been victimized by such practices) and created the now-common additional condition coinsurance provision. Insureds are encouraged to insure a very high percentage of the structure’s total insurable value. Such requirement allows property insurers to charge adequate yet not excessive rates.

What All That Has to do With Clients

A majority of clients are probably not interested in MPL’s, PML’s or statistics, so explaining the computations and risks underlying the coinsurance provision may not be necessary (or even wanted). But having the necessary background information allows the industry to better relate to the insured that the coinsurance condition is not, of itself, a penalty; rather it’s a claims payment and rating provision allowing insurers to keep property rates lower than they otherwise could if insureds were allowed to purchase whatever amount of coverage they so desired without penalty, regardless of the total insurable value of the structure being protected.

But even this universal coinsurance truth is nebulous to the insured. The insured simply wants to know what is required to avoid the coinsurance penalty and how their coverage and ultimate loss payment is affected by the requirement.

Simply Put

Coinsurance provisions found in property policies require the insured to purchase and maintain some percentage of the structures total insurable value (TIV). The most common requirement is 80 percent of the structure’s TIV at the time of the loss; this means that if the insured structure’s TIV is $100,000 and there is an 80 percent coinsurance requirement, the insured must carry $80,000 of coverage to receive full payment for a partial loss (less any deductible). (Note the phrase, “partial loss.” The insured NEVER gets more than the limits purchased, so they are still underinsured for a loss exceeding the limits of coverage.)

The simplified coinsurance calculation is: Did/Should x Loss – Deductible = Payment

As stated, this is the simplified coinsurance calculation. Development of “Should” is actually a two-step process.

Insureds lacking adequate limits of coverage at the time of the loss are subject to the penalty prescribed by the coinsurance condition. In effect, the insured becomes a “co-insurer” of the loss because they have chosen to carry less than the contractually-required amount of coverage – thus the term, “coinsurance.”

Following

Describing the coinsurance provision and calculating the results of a “coinsured” loss are simple. A more advanced discussion of coinsurance and the commercial property policy is scheduled for this Thursday (8/13). This webinar details:

• Why coinsurance exists;
• The results if there was NO coinsurance provision;
• Examples of how to recognize the differences between Maximum Possible Loss (MPL) and Probable Maximum Loss (PML);
• The ACTUAL coinsurance calculation; and
• Key coinsurance conditions and ideas.

Join us Thursday so that you are ready to finally explain this condition correctly.

Topics Profit Loss Property Medical Professional Liability