Do you really know how much insurance coverage you'll have if you need to file a claim? Your coverage limits aren't the only factor that could reduce the claims payout you receive. Many property insurance policies have a coinsurance clause, and if the coinsurance requirements aren't met, your claims payouts could be reduced. Here's what you need to know about the coinsurance clause in your landlord insurance policy.
The Coinsurance Agreement
The coinsurance clause is common in property insurance policies, but policyholders don't always understand it.
Let's say you have an apartment insurance policy with a coverage limit of $500,000. You have a claim for $100,000. That's well under your policy limit, so when you file the claim, you feel confident that you'll receive a payout for the full amount of the claim. Then you get the claim payment, and it's a lot less than you expected.
The deductible could be part of the reason. When you file a claim, the deductible is your out-of-pocket share of the cost. Picking a high deductible can help you secure a lower premium, but if you go this route, you'll have to pay more if you have a claim. It's a tradeoff that deserves thoughtful consideration.
But what if you've accounted for the deductible, and your claim payment is still lower than expected? In this case, the coinsurance requirement may be the issue.
How the Coinsurance Requirement Works
The coinsurance clause requires you to purchase a policy with a coverage limit that equals or exceeds a set percentage of your property's value. Essentially, the requirement acts to discourage policyholders from underinsuring their property.
For example, let's say your property is worth $600,000.
- If you have a 100% coinsurance clause, you need to purchase a policy with a coverage limit of 100% of $600,000, which is $600,000.
- If you have a 90% coinsurance clause, you need to purchase a policy with a coverage limit of at least 90% of $600,000, which is $540,000.
- If you have an 80% coinsurance clause, you need to purchase a policy with a coverage limit of at least 80% of $600,000, which is $480,000.
Coinsurance clauses of 80% or 90% are common, but the requirement can vary. It’s important to check your policy for details.
The Coinsurance Penalty
If you do not meet the coinsurance requirement, a penalty will be applied to your claims payments. As a result, you will receive less than the amount of the claim, even if the claim is less than the coverage limit.
Here’s how the payment amount is typically determined when a coinsurance penalty applies:
- Divide the amount of coverage that you have by the amount of coverage required under the coinsurance clause. Because you have less coverage than is required, this will give you an amount of less than 1.
- Multiply the number from the first step by the amount of the claim. This will give you an amount that is less than the amount of the claim.
- The deductible still applies, so now you need to subtract the deductible. This is how much the insurer will pay.
For example, let’s say you have a property that’s valued at $600,000 and (for simplicity’s sake) a 100% coinsurance clause. This means that you need a coverage limit of $600,000 to meet the coinsurance requirement. But in this example, you have a limit of $450,000. That’s less than the requirement, so the penalty applies. By dividing $450,000 (the amount of coverage you have) by $600,000 (the amount of coverage required), we get 0.75. Any claim amount subject to the coinsurance clause will be multiplied by 0.75. If you have a claim of $5,000, you get $3,750 ($5,000 x 0.75 = $3,750) minus the deductible. If you have a claim of $200,000, you get $150,000 ($200,000 x 0.75 = $150,000) minus the deductible.
By playing around with the possible numbers, we can see that the coinsurance penalty can be significant. As the difference between the amount of coverage you have and the value of your property increases, the penalty also increases.
The examples used above are intended to help illustrate some possible scenarios, but your figures will probably look different. The language and amounts used in coinsurance clauses can vary, so you need to know what’s in your policy.
Solving the Coinsurance Problem
An apartment building coinsurance clause isn’t necessarily a problem, but it can become a problem if the policyholder doesn’t understand the requirement and receives a payout that is significantly below the expected amount.
There are three basic ways to deal with this issue:
- Avoid buying a policy with a coinsurance clause. The coinsurance clause is common in property insurance policies, but you may be able to find a policy that meets your coverage needs and does not include this requirement. Just make sure you read your policy carefully. You don’t want to assume there is no coinsurance clause only to find out later that there is one and, worse, you haven’t met the requirement.
- Insure your property at a level that satisfies the coinsurance clause. This way, you don’t have to worry about the coinsurance penalty. Also, if you suffer a large loss, you may be thankful for the high limits. But make sure that you have an accurate and current value for the property and that you and your insurer agree on the amount of coverage needed. Keep in mind that property values can change, and the differences might be significant. You’ll need to adjust your coverage limits as your property’s value increases.
- Accept the coinsurance penalty. If you are willing to take on some of the risk yourself – and you have the funds to do so – you may be willing to accept the coinsurance penalty and lower limits in exchange for an attractive premium. However, you want to make sure that you’re not setting yourself up for a financial disaster. Consider worst-case scenarios and make sure you’re comfortable with the level of risk you’re accepting.
Don’t Be Caught by Surprise
Don’t let a coinsurance clause take you by surprise. Honeycomb can help you get the insurance coverage you need.