I was just informed by the adjustor that we did not carry enough insurance on the building which suffered a loss, and have a co-insurance penalty? What does that mean?…
Simply put, it means that the building was not adequately insured based on the replacement cost of the building. Let’s say your insurance contract states that the co-insurance penalty is 80%.
Suppose you own a 10,000 sq ft building and believe it is worth $400,000 and so you insure it for $320,000, and assume the 80% insurance requirement is satisfied. Now suppose there was a covered loss to this building, say it caught on fire and there was $180,000 worth of damage and a claim was filed. The insurance company subsequently determines that the replacement cost for the building is not $400,000, but actually $550,000.
The formula used by the insurance company to determine what they will pay is (DID/SHOULD) x LOSS.
In this case, you purchased $320,000. Should have purchased $440,000 ($550,000 true replacement cost x 0.80).
The insurance company will pay ($320,000/$440,000) x $180,000 = $130,909 and the difference of $49,091 will be the penalty you suffer for not adequately insuring the building to true limits.
So, what is this co-insurance agreement?
Essentially, it is an agreement between you and the insurance company stating that the property is insured for at least “ xx% “of the replacement cost. Not what you think the property is worth, or how much you owe on the property, or how much you can sell the building for, but the replacement cost of the property. There are a number of different ways to determine the replacement cost on a building, and as can be seen from the above example, it is important that the building be sufficiently insured to avoid the co-insurance penalty. Also, the co-insurance penalty does not only apply to property, it can also apply to business loss of income, Inland Marine and other policies. So it is important to review the insurance requirements on an annual basis, or sooner, if there has been a significant change in business levels.