Clarifying The Co-insurance Clause

Co-insurance is a cost-sharing arrangement between an insurance policyholder and their insurance provider. It can be found on various policies such as contents, products, equipment, commercial insurance and home insurance.

This clause serves two purposes: ensuring that policyholders adequately insure their property and that the insurer receives a fair premium for the associated risk. It applies whether the coverage is based on the property's replacement cost or its actual cash value, which takes depreciation into account.

The co-insurance clause can also be present in business interruption insurance, which mandates that policyholders insure their revenue stream to an appropriate value.

It is a percentage-based amount that individuals must pay out of pocket for covered expenses after paying their deductible. One of the most common coinsurance breakdowns is the 80/20 split. Under an 80/20 co-insurance plan, the insured is billed for 20% of costs while the insurer pays 80%. Some policies will have 90% or 100% of the value covered.

If a building is worth $1,000,000 to replace and the insurance policy has an 80% co-insurance clause, it must be insured for at least $800,000 to comply with the 80/20 plan. Likewise, if the co-insurance clause is 90%, the building must be insured for a minimum of $900,000 to meet the requirement.

Example of co-insurance

Let’s say you own a commercial building. This building has a replacement cost value of $2,000,000. As part of your policy, you have a co-insurance clause that is 90%. This means you are required to insure your building for $1,800,000 (90% of $2 million). You have a fire that causes $500,000 in loss. You open an insurance claim.

Apply the co-insurance formula

To figure out your claim amount, you would use the following formula:

(Coverage limit / Value of property or replacement cost) * Amount of loss = Amount of claim.

Here is a breakdown of the numbers:

($1,800,000 / $2,000,000) * $500,000 = $450,000.

In this situation, your insurer would be required to pay out $450,000 for the claim (90%). You would be required to pay $50,000 - the 10% co-pay. You will also be required to pay the policy deductible.

Co-insurance and co-payment are two different concepts that are often confused. Co-insurance is a cost-sharing arrangement based on a percentage, while co-payment is a fixed amount that policyholders pay for specific medical services. Co-payments are usually lower and paid upfront, while co-insurance is paid after the insurance company processes the claim.

Different co-insurance percentages are typically associated with specific types of insurance coverage. Here are the typical applications:

80% co-insurance is commonly used for:

• Property insured based on the actual cash value (depreciated value).
• Stock in trade.
• Business interruption coverage for gross earnings.

90% co-insurance is commonly used for:

• Buildings and contents are insured for replacement cost.
• Industrial equipment coverage.

100% co-insurance is typically used for:

• Business interruption coverage for profits.

Generally, insurance companies don't permit the removal of co-insurance as they need to ensure they receive a premium that accurately reflects the total reconstruction value of the insured property while also providing coverage.

Nonetheless, an insurer may replace the percentage-based co-insurance clause with a "stated amount co-insurance" clause in specific circumstances. The policyholder must prove to the insurer that the coverage amount reasonably approximates the actual cost to obtain this.

A "reconstruction appraisal" is typically required as the market value or purchase price can differ significantly from the replacement cost. Relying solely on market value or purchase price may lead to unpleasant surprises in case of a loss.