Coinsurance for Property – The Consumer’s Perspective

If you are confused by coinsurance, you are not alone. People are often convinced that purchasing a policy with coinsurance is a great idea because it is cheaper – only to discover when they make a claim that they have lost half of their coverage. So, is the savings worth it?

How Coinsurance Works

Let’s say you are at your broker or agent’s office, and you intend to purchase homeowner’s insurance. “But,” you tell your agent, “my budget is a little tight – we have to keep the premiums as low as possible.” The agent says this is no problem, and you should consider coinsurance. You ask, “What is coinsurance?”

Look at all the money you can save!

The agent explains that coinsurance is an option offered by insurance companies that, in exchange for lower premiums, you will agree with your insurer to maintain a certain amount of insurance on your property. For example, if your home is worth $1,000,000, you agree with your insurance company that you will keep it 80% insured, or insured for an $800,000 loss.

Note that this doesn’t mean you are purchasing $800,000 worth of coverage from this same insurer. You can purchase less than 80% from the insurance company you make a coinsurance agreement with (your coinsurer). Then, you independently decide if you wish to purchase more coverage from another company  – or just keep the property insured at less than its full value and save even more in premium payments. But, there is a catch –

Cheaper in the Short Run but Very Costly in the Long Run?

If you fail to keep your property covered at the percentage you agreed upon with your coinsurer, your coinsurer will penalize you when you make a claim. Penalties vary according to specific policies, but in general they operate in like this –

  •  You agree with your coinsurer to insure your $1,000,000 property at 80%. You insure the property for $500,000 with your coinsurer, or 50%. You do not purchase any other insurance for the property. A fire occurs on the property, causing damage costing $400,000. When you  make your claim, your coinsurer says, “Because you only insured the property for 50%, which is less than the required 80%, we will only pay for 50% of the claim. Here is your check for $200,000.”
Underinsure and you may end up like Detroit. Bankrupt.

People are often shocked at this result. After all, if you have $500,000 worth of coverage with your coinsurer, why aren’t they paying the entire loss amount of $400,000? It isn’t over your limit. They aren’t paying because your policy has a coinsurance penalty. Purchasing coinsurance without understanding it fully can be dangerous, and ultimately, very expensive.

This makes coinsurance seem like a terrible idea. However, imagine the same scenario above, only in this example, you experience a total loss of $1,000,000. Because you only insured at 50%, your coinsurer will pay you 50% of your $1,000,000 loss. You are paid $500,000 – your policy limit. So when you have a total loss under a coinsurance agreement, you actually receive your entire coverage.

Aristotle, founder of common sense. He doesn’t understand coinsurance either.

The thing to remember about coinsurance is this:  the larger your property damage, the less you are penalized by your coinsurer.

From the insurance company’s perspective, their offering of coinsurance and the slightly discounted premium gives them the opportunity to slash your benefits at compounded rates, under the guise of the “coinsurance penalty.” Insurers know this is a great deal because statistically, almost every person purchasing coinsurance will be subjected to the hefty penalty when they make a claim. This is because total losses do not occur very frequently – which makes sense, if you think about it. Floods and fires are generally stopped before they take out an entire building.

Coinsurance as a Tool

By now, coinsurance is probably sounding like a very bad deal. However, there may be, at least in theory, a way to make coinsurance work in your favor. Let’s say, as in the example above, you opt for coinsurance at 80% and then purchase 50% coverage with your coinsurer. You receive a discounted premium. Then, you approach insurance company Number 2 and purchase either a blanket/umbrella coverage to completely cover all of your properties at a discount, or you purchase another 30% coverage for the original property, which would bring your total coverage to 80%. Depending on the premiums you obtained with insurance company Number 2, this use of two companies and the coinsurance might be cheaper than fully insuring with just one company. Then again, it might also be twice the amount of headaches.