A replacement cost appraisal can help prevent a co-insurance penalty on a property’s insurance policy by accurately determining the full replacement value of the property and the amount to be insured. If a co-insurance clause is present on your policy, you could be at risk of severe penalties and ineligible for full payouts in the case of a total or even partial loss.
Co-insurance is a term commonly used in insurance policies. It refers to the cost-sharing arrangement between the insurance provider and the insured individual or policyholder.
A co-insurance clause requires policyholders to insure their property for a specified percentage of its full replacement value, typically ranging from 80% to 100%. If the property is not insured to the specified percentage, a co-insurance penalty may be applied in the event of a claim.
Suppose you own a building and the replacement cost is $1,000,000. Your property insurance policy has a co-insurance requirement of 80%. This means that you must insure the property for at least $800,000 to receive the maximum amount of coverage. Instead, you choose to insure the property for only $600,000. In this scenario, the insurance company will apply the co-insurance formula to calculate the payout amount in the event of a claim.
Co-insurance formula: ([Policy limit / Required limit] x Loss) – Deductible = Claim payment
The policy limit would be $600,000. The required limit is $800,000 (80% of the total replacement cost).
Let’s consider two examples to understand how co-insurance would apply to property losses.
Example One – Partial Loss
There is a water leak in your building causing $200,000 worth of damage. The deductible is $5,000. Since you insured the property for only $600,000, the insurance company will consider your coverage to be insufficient. They will calculate the penalty for underinsurance based on the co-insurance formula.
In this case, the calculation would be:
([$600,000 / $800,000] x $200,000) – $5,000 = $145,000
This means that the insurance company will only pay $145,000 for the claim, and you would be responsible for the remaining $50,000 out of pocket, plus the deductible.
Had you had insured the property for at least 80% of its value, the co-insurance penalty would not have been triggered and you would have received the full $200,000, minus the deductible.
Example Two – Total Loss
In the case of a property claim that results in a total loss, the co-insurance clause can have a significant impact on the amount of reimbursement you receive from the insurance company.
Using the same values from the last example, consider there is a fire that results in a total loss of the building. The deductible is $25,000. In this scenario, the loss value would be the maximum limit of coverage, which is $600,000.
Using the co-insurance formula:
([$600,000 / $800,000] x $600,000) – $25,000 = $425,000
Based on this, the insurance company would only reimburse you for $450,000 based on the co-insurance penalty, minus the deductible.
In order to rebuild the same property, at an estimated $1,000,000 replacement cost value, you would be responsible for paying the remaining $550,000 out of pocket, plus the policy deductible.
Obtain an Appraisal to Avoid Co-Insurance
Co-insurance is designed to encourage policyholders to adequately insure their property. It serves as a mechanism to distribute risk between the insurer and the policyholder. Insuring your property to the full replacement cost can help avoid co-insurance penalties and ensure sufficient coverage in the case of a loss. Only a credible, experienced appraisal firm can reliably determine the full replacement cost of a property.
Steps to Avoiding Co-Insurance
- Engage a third-party, professional firm specializing in replacement cost valuations (like Normac).
- Obtain appraisals on an annual basis and insure your property to the full replacement cost amount.
- Share the appraisal with your insurance provider at the time of the insurance policy renewal. Bonus: if you align the appraisal program effective date with the insurance policy renewal date, you can ensure accuracy and avoid midterm adjustments.
- Have peace of mind that your assets are protected in the case of a loss.
Normac’s Insurance Appraisal Experts
Normac is the largest specialized insurance appraisal company in Canada. Our team has extensive knowledge of construction costs, utilizes our own proprietary costing database, and provides industry-leading reports with additional details to maximize your coverage potential and help you to secure the best terms.
Losses do happen. Request a no-obligation quote today and mitigate the risk of a co-insurance penalty.