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Common Insurance Terms – Co-Insurance

March 27, 2013

The term “co-insurance” is often used to describe the joint assumption of a risk by multiple parties. Where the parties “splitting” the risk are the insurer and the insured, several schemes exist to provide co-insurance. Which scheme is used in a given policy will depend largely on the type of exposure being insured.

By way of a quick comparison, co-insurance is different from a deductible. While both deductibles and co-insurance provisions offer the insured a way to retain some risk and possibly lower his or her premium, a deductible is usually stated in terms of the fixed amount to be paid out of pocket before an insurer will pay any expenses. Co-insurance, on the other hand, is often expressed in terms of the percentage of risk allocated to each party so that one or both parties’ share of expenses scales with the magnitude of the insured loss.

The details of how a co-insurance provision operates can vary widely based on policy type. The following is a very high level look at how co-insurance commonly operates in property and commercial liability policies.

Property Insurance

In a property policy, a co-insurance provision may take the form of a penalty imposed by the insurer for underreporting or underinsuring the value of physical property or business income. The penalty is calculated based on the “co-insurance percentage” stated in the policy and the amount underreported according to the formula:

Amount of Insurance Purchased (Limit) ÷ (Actual Value × Co-insurance Percentage)
× Amount of Loss

Let’s say a building actually valued at $1,000,000 has an 80% co-insurance clause but is insured for only $700,000. Since its insured value is less than 80% of its actual value, when it suffers a loss, the insurance payout will be subject to the underreporting penalty. For example: It suffers a $200,000 loss. The insured would recover $700,ooo ÷ (0.80 × 1,000,000) × 200,000 = $175,000 (less any deductible. In this example, the underreporting penalty would be $25,000.

The co-insurance percentage issued most commonly in property policies is 80% but can be as high as 100%. This is why it is important to accurately report the values of property and to update values annually taking into account inflation and other increases in cost.

Liability Insurance

In some cases, including Employment Liability Insurance, the coinsurance percentage indicates the percentage of the loss covered by the insured, up to a certain level, before the carrier pays remaining expenses. For example, an Employment Liability policy may require the insured to pay 10% of costs arising from a suit or $3,000 (whichever is less) before insurance kicks in. These numbers are, of course, arbitrary but they serve to illustrate how such a policy might function.

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