Since the concept of Co-Insurance is a fundamental principal of property and business continuation insurance, it is imperative that you understand it before deciding the amount of insurance you buy.
Co-Insurance is an agreement between YOU and the Insurance Company, whereby you agree to maintain coverage up to a stated percentage of the value of the property you wish to insure (usually 80%, 90% or 100%). As a result of this promise, a significant reduction in the rate is given.
Should a loss occur, consideration is then given to the amount of insurance carried compared to actual values prior to the loss. If the amount of insurance is within the agreed Co-Insurance percentage requirement, the loss is paid in full, up to the policy limits. If, however the amount of insurance that you carry is below the agreed co-insurance percentage, YOU and the Insurer then share the amount of the loss.
Assume the actual rebuilding cost of a building you are insuring is $1,000,000 and the policy contains a 90% Co-Insurance requirement. This means you should have a minimum limit of $900,000 on the building ($1,000,000 x 90%). If you only had a limit of $500,000 (when you needed to have a minimum limit of $900,000 to meet the co-insurance requirement) and had a claim worth $350,000, your Insurance Company would only pay you $194,444 based upon the following formula:
(amount of insurance ÷co-insurance requirement) x amount of loss = claim payment
($500,000 ÷ $900,000) x $350,000 = $194,444
In this example, the insurance company would pay $194,444 towards the claim and you would be responsible for paying $155,556 of the claim ($350,000 – 194,444).
We recommend your insurable values be regularly reviewed if co-insurance penalties are to be avoided.