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Co-Insurance Explained: Maximizing Protection with a Replacement Cost Appraisal

Co-Insurance Explained: Maximizing Protection with a Replacement Cost Appraisal

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 penalties and ineligible for full payouts in the case of a loss.

Understanding Co-Insurance 

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:

Claim Payment = ([Policy limit / Required limit] x Loss Amount) – Deductible


The policy limit would be $600,000. The required limit is $800,000 (80% of the total replacement cost).

Let’s consider a few scenarios to understand how co-insurance would apply to property losses.

Example One: Partial Loss, Co-Insurance Requirement Not Met

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 $5,000 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: Partial Loss, Co-Insurance Requirement Not Met

In the case of a property claim that results in a higher loss, the co-insurance clause can have a significant impact on the amount of reimbursement you receive from the insurance company. 


Consider there is a fire that results in damage to the building up to $750,000. The deductible is $25,000. 


Using the co-insurance formula:

([$600,000 / $800,000] x $750,000) – $25,000 = $537,500


Based on this, the insurance company would only reimburse you $562,500 for the claim, and you would be responsible for the remaining $187,500 plus the $25,000 deductible.  

Example Three: Partial Loss, Co-Insurance Requirements Satisfied

In our next example, we will use the same metrics for a partial loss on a property that has a replacement cost value of $1,000,000 and a deductible of $25,000. However, in this case, we will assume that you have insured the building for $900,000 which would be the policy limit. 


Using the same values, consider there is a fire that results in damage to the building up to $750,000. The deductible is $25,000.  


In this case, the policy limit exceeds the minimum required limit of $800,000 which means that a co-insurance clause or penalty would not apply. While on any loss, the insurance recovery is still capped at $900,000, any claim under that amount would be covered and you would only pay the deductible.  

Example Four – Total Loss, Insured to Value

In our last example, you have insured the property to full replacement cost value at $1,000,000, as per your current insurance appraisal. The property experiences a fire and is deemed a total loss. You can be confident that you will be sufficiently and accurately covered and will only responsible for paying your 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

  1. Engage a third-party, professional firm specializing in replacement cost valuations (like Normac).

  2. Obtain appraisals on an annual basis and insure your property to the full replacement cost amount.

An accurate insurance appraisal should consider all costs to rebuild, including all hard and soft costs, and should account for demolition and removal, upgrades required to meet current building code and bylaws, fluctuation to construction costs, and regional costing.

  1. 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.
  2. The co-insurance clause will be waived on your policy and you can have peace of mind that your assets are sufficiently protected in the case of a loss. 

When placing property insurance and determining policy limits, remember that insuring to value can help you avoid any potential co-insurance penalties when experiencing a loss. An insurance appraisal can not only provide peace of mind, but also reduce the risk of significant financial losses.  


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. 

Normac provides three-year appraisal programs with complimentary updates. 
Our industry-leading reports are prepared by replacement cost experts.

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