Today we continue our introductory series to Commercial Lines meant for personal lines focused agents, CSRs and underwriters who are looking at transitioning into commercial lines. One of the often confusing aspects of commercial lines is the concept of co-insurance. But don’t despair, we’ll break it down to it’s basic components!
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Commercial property policies have multiple ways of valuing property. The two most common are:
- Actual Cash Value – This is the value of the property at the time of the loss, or the replacement cost of the property minus depreciation.
- Replacement Cost – This is the cost of the property if it had to be replaced. In other words, a property might cost more to be replaced than it would cost if it were to be sold.
Co-insurance comes into play when properties are insured for Replacement Cost and enables insurance carriers to be sure they are getting the right amount of premium for the property they are covering. On building and business personal property (contents), co-insurance is usually 80%, 90%, or 100%. It is important to understand what this means when insuring a property as it could have a very negative effect if a claim were to occur.
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The value of property that is listed on the policy should always be equal to the co-insurance times the replacement cost. Here’s an example:
The insured estimates that the cost to replace and rebuild their building is $1,000,000. They have an 80% co-insurance clause: $1,000,000 x 80% = $800,000.
They should insure the building for at least $800,000. It would be safer to insure for a little bit more to make sure you have some wiggle room in case costs increase before a claims happens, but the higher you insure it for the more premium you’re paying.
If you only insured the building for $600,000 and there was a fire causing half of the building to burn down ($300,000 of damage). Because they did not insure the building for $800,000, they didn’t satisfy the co-insurance requirement and will be penalized on the claim. The carrier will not pay for the entire building to be replaced. Here’s how they will pay out:
- They will take the amount of coverage the insured did purchase ($600,000) and divide it by what they should have purchased ($800,000).
- Then, they will multiply this percentage times the loss amount to come up with the settlement. The calculated amount is what the carrier will pay.
A simple mistake like this and your insured just ended up with a $75,000 out of pocket loss because they didn’t properly insure the building!
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This is what your customer looks like after the find out a big part of the loss is going to be out of pocket because you messed up the co-insurance on his policy. Don’t let it happen to you! There are several tools available for agents to help an insured be sure they are adequately covered such as the very commonly used MSB.
The third most common settlement option is an Agreed Value clause. With this option, the insured completes a Statement of Values indicating the Replacement Cost values of their properties. The underwriter must agree that the values are adequate and will waive the co-insurance clause. If there’s a loss, the policy would pay the cost to replace the property or the maximum as stated on the declaration page if it was a total loss.