Co-insurance, as it pertains to businesses, is a penalty imposed on the insured by the insurance company for under insuring the value of a building or business property. Almost all property policies have some kind of co-insurance clause. While you can usually clearly see the co-insurance percentage on a property policy, the clause on a business owner’s policy (BOP) is usually not as obvious. A commonly used phrase for co-insurance on a BOP is the “insured to value” clause.
The most common coinsurance percentages are 80%, 90% and 100%. Accurately insuring your property at the proper value is critical, as a penalty can and likely will be imposed if you are found to have under reported the value of your property. Business owners sometimes under report the value of the property to pay a lower premium; however, this is NOT recommended. It is critical that values be accurately reported and updated to reflect inflation and other increases in cost.
The formula used for the co-insurance clause is as follows:
Loss x [Limit of Insurance ÷ (Actual value of property at Time of Loss x Co-insurance percentage)]
= Loss Settlement
The following example, illustrates the potential consequence of underreporting the value of your property:
A building actually valued at $1,000,000 has an 80% coinsurance clause but is insured for only $750,000. Since its insured value is less than 80% of its actual value, when it suffers a loss, the insurance payout will be subject to the underreporting penalty. For example: It suffers a $200,000 loss. The insured would recover $750,000 ÷[$200,000 × (.80 × $1,000,000)] = $187,500 (less any deductible).
In this example the underreporting penalty would be $12,500.