What Is Coinsurance in Business?

What is coinsurance for businesses?

Coinsurance clauses in small business insurance policies apply primarily to business property, including vehicles, buildings and office equipment. The coinsurance clause outlines the percentage of the property’s value that a policy owner must insure to receive full payment on a claim if a loss occurs. 

Why do insurance companies offer coinsurance?

With a coinsurance clause, the insurer knows you have adequate coverage if you must file an insurance claim. Coinsurance protects the insurance company’s ability to pay out claims for policy owners, assist with underwriting, and determine insurance premiums. 

The insurer applies coinsurance percentage rates to business property or business income. This percentage depends on the property value covered under the policy owner’s plan, such as actual cash value and replacement cost value.

How does coinsurance work on a commercial property?

Let’s say an insurer requires the amount of insurance you purchase on a property to be 80 percent of the property’s value to cover replacement costs adequately. For example, if your property is worth $100,000, you must insure it for at least $80,000.

In this example, the insurance limit would be 80 percent of the property’s value. If you fail to meet this required coverage and you file a claim on damaged property that exceeds the coverage limit, you’ll face a penalty to make up for the inadequate insurance (also known as the insurance shortfall). 

Check your policy for the specific coinsurance percentage requirements associated with your property’s value and any penalties the insurer could impose. 

What is a 100 percent coinsurance clause?

When you’re reviewing policy options, it may seem like most property insurance possibilities involve coinsurance, in which each party shares a percentage of the claim. While this is a valid assumption, it’s not always the case. 

Under a 100 percent coinsurance clause, the business owner must insure 100 percent of the property’s value. The policy’s premium costs are typically lower because the insurer doesn’t take on the same risk as it would with an 80 percent policy, in which the insurer pays out 20 percent if a claim is filed.

However, business owners should consider two things: 

• You risk underinsuring the asset if its value rises after you purchase the policy. Think of rising commodity inventories, such as coffee, or land, such as real estate.  
• If the asset’s value increase isn’t accurately recorded (such as a property value that rises from $100,000 to $160,000) and the property value is actually higher than the policy limit (for example, at $100,000 for a 100 percent coinsurance clause), you could be required to pay the uninsured shortfall. In this example, that would be $60,000 (minus the deductible) if the property is entirely damaged, because the $100,000 policy covers only 70 percent of the $160,000 valued property. The cost of this underinsured property could outweigh the premium savings under a 100 percent coinsurance policy.

What is a coinsurance penalty clause?

A coinsurance penalty clause, often found on the insurance policy’s declaration page, penalizes the policy owner for not sufficiently insuring the property. These clauses require you to carry a specific amount of insurance based on the value of the covered property.

How to avoid coinsurance penalties

There are three ways policy owners can avoid coinsurance penalties: 

1. Agreed value for business property insurance coverage 

Agreed value is often a higher-priced coverage option. Under this option, you and the insurer agree on the total value of all of your physical assets or property. The policy limits must equal the agreed-upon value. 

Agreed value specifically requires a property value statement that you submit to the insurance company before the policy is issued or renewed. You must meet all of the stipulations defined in the policy to avoid a coinsurance penalty. 

For example, if your coffee inventory stock would cost $2,000 to replace, you must insure it for at least 100 percent of the agreed value of $2,000 to avoid a shortfall and a coinsurance penalty if your inventory (commodity price) rises in value at the time of the loss.

This is the formula for agreed value:      

Percentage of coinsurance x estimated net income and expenses for the time period specified by the insurer = Agreed value

2. Agreed value for business income insurance 

Agreed value for business income insurance works similarly to agreed value in property insurance. However, in this case, since business income insurance replaces lost income, you must submit a business income worksheet listing your business’s projected revenues and expenses during a period specified by the insurance company. You must submit this information before the policy is issued or renewed each year. 

3. Value reporting and accounting

Although the premium savings for this option are often minimal, value reporting accounting makes sense for companies with inventory levels that vary throughout the year. This means the policy amount and premium adjust according to the fluctuating inventory value.

Value reporting helps prevent overinsuring inventory that may decline in value at a certain point in the year. However, your small business must have highly accurate inventory value reporting to be paid out for a valid claim.

The insurer typically determines the premium based on this formula: 

Value of the business ÷ $100 x insurer’s premium rates

Here are some key points to consider: 

• There are typically two premium rate options: monthly and annual.
• Your business, as the policy owner, will be responsible for reporting inventory levels to the insurer during each month’s designated period.
• If the inventory exceeds the reported value at the most recent period before the time of the loss, you may have a coverage shortfall. If your insurer finds you did not report accurate inventory levels, that could have grave implications for you as the policy owner.

Mark Fairlie contributed to this article.