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Insuring to Value and Co-Insurance

When we look at commercial insurance, we often think about the premium but what makes up the premium in the policy?  The main ingredients are building value, stock, and equipment but there are many other coverages that affect the premium.  However, when it comes to rebuilding or replacing, these coverages drive much of the policy and what could or could not be paid in the event of a claim.

Insuring to value is to ensure that the correct amount of insurance by dollar value is purchased to cover the cost of a claim.  Considering many claims are not total losses the indemnification can be complicated when assessing the loss value and how that relates to the insurance purchased and one of the reasons business and commercial building owners need to be aware of the co-insurance clause.

As an example, a commercial business where the business owns the building can provide a guide into how co-insurance works and affect the payout of a claim.  When the policy is submitted to the commercial underwriter the agreed upon terms had the building value at $500,000 and the equipment at $350,000 and the stock at $200,000 for a total TIV, total insured value of $1,050,000.

These values were arrived from discussion with the insured and the broker with the insured providing all values and assuring they were up to date with building trends.  The broker used a building valuation program and came up with a valuation of $675,000 for the building but the insured insisted on submitting the application with the $500,000 number. 

During the policy period there was a fire and the building was largely damaged due to the fire as well as some stock and equipment.  The business owner made a claim and when the insurance adjuster came out to inspect the loss and damage, they worked on how much the damage would cost to repair.  

The co-insurance clause used on commercial polices is designed to encourage that owners insured to the proper value of the property.  Many policies have a 90% or 80% co-insurance minimum which means to avoid penalty the value must be insured to 90 or 80 percent of the full value. 

In the example above the property was insured for $500,000 but should have been insured for $675,000 so did it meet either the 90% or 80% co-insurance minimum?  675,0000 x 90%= 607,500 and 675,00x80%= 540,000 so the building was under-insured to meet the co-insurance minimum.  If the clause stated 90% the payout for the building would be as following calculation:  the insured value divided by total value.  Using 500,000/607,500 for a ratio of .823, the loss covered would be $500,000 x .823=$411,500.  If the %80 number was used the calculation works like this:  500,000/540,000=.925 for a payout of $462,500. 

If the loss was a partial loss and not a total loss, with the damage being estimated at $275,000 the formula would work like this:  90% co-insurance ratio of .823x275,000=$226,325 of coverage and with 80% .925x275,000=$254,375. 

While the co-insurance clause exists to prompt clients to insure to the most accurate valuation possible using available tools, it does allow insureds to manage premium by being close enough at either 80 or 90 percent of TIV. The reasoning here is that should a property suffer that level of damage it will be a total loss and unrepairable so the insurance company will pay the full amount.  To avoid the use of the co-insurance clause insuring to the total replacement value is the best and to insure to the minimum amount required by the co-insurance clause. 

Some companies will offer other ways to ensure adequate coverage and that is using an agreed value coverage process.  This option is a submission to the insurer on an agreed upon value of buildings, stock and equipment submitted before the policy begins or before renewal each year.  Consulting with your broker is the best way to ensure your risk profile is respected with your insurance policy so that you know the risks of co-insurance and other limitations contained in your policy. 

Written By: BSI