Failing To Obtain Regular Appraisals Can Hurt Associations After A Large Loss

The second named storm of the year has crossed Florida, and it will only be a matter of time before another tropical system strikes the state. While there are many problems that an association can face after a loss, few are harsher than the effect of a coinsurance penalty that reduces the amount paid on an otherwise valid claim. Many policies, especially large commercial polices, contain coinsurance provisions. Unfortunately, many directors and managers do not understand what they mean or the effect that they can have.

Coinsurance provisions come in all shapes and sizes, but the most common are 80, 90, and 100% coinsurance provisions. These provisions are fairly easy to understand. Because an insured is supposed to carry enough insurance to replace the entire property after a loss, insurers will reduce the amount of coverage they provide if this is indeed not done. An 80% coinsurance provision means that an insured must have coverage for 80% or more of the replacement cost value at the time of the loss. Likewise, with a 100% coinsurance provision the insured must have coverage for 100% of the replacement cost value at the time of a loss.

If a property does not have enough insurance coverage to equal or exceed the coinsurance provision, the insurer may reduce the amount of recovery even if the cause and amount of the loss are undisputed. This is a harsh effect and may leave an association without the funds to properly repair the buildings.

There are two basic ways that an insurer will reduce payments under coinsurance provisions. First, an insurer may only pay the actual cash value of the damage instead of the replacement cost normally covered under the policy. While this may not seem too harsh for newer properties, failing to recover the depreciation can be a huge problem for older associations.

The second, and more common, coinsurance provision states that if the property is not insured to the required percentage, any loss can be prorated to the percentage of the insurance purchased. For example, if a policy had a 100% coinsurance provision, the building would need to be insured to 100% of its replacement cost value at the time of the loss. If only $100,000 worth of insurance was purchased but the Replacement Cost Value of the property was $200,000, the insurer would only be liable for 50% of the loss.

Thus, if there was a policy limits loss of $100,000 dollars in the above scenario, the insurance company would only be required to pay $50,000 because the property was only insured to 50% of its replacement cost value.

Many associations carry high coinsurance provisions for a number of reasons. Higher coinsurance provisions reduce premiums, which is enticing to many associations looking to save money in tough financial times. Also, many associations cannot imagine a total loss and believe that there is no need to fully insure the property. Others may not even know that the provision is in their policy. No matter what the reason, associations should always check the amount of the coinsurance provision and ensure that they are adequately covered.

If the association policy includes a coinsurance provision, it should be between 80 and 90%. Having a 100% coinsurance penalty is almost never recommended. Also, no matter what your coinsurance provision says, an association should make a habit of having professional appraisals performed on a regular basis. Having a qualified and unbiased third party determine the replacement cost of the property every few years will ensure there is adequate insurance on the property.

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kurtis draxl - August 5, 2010 8:25 PM

Question Re: coinsurance on a windstorm policy

If replacement cost is $1,000.000 but I purchase a policy with a 100% coinsurance provision for $800,000 coverage with a 80% coinsurance would I still be covered for

Please explain this scenario as someone tried to sell me such a policy. Thanks a lot!

PS. Would it not be as cheap or same price to purchase $1,000.000 replacement cost without the 80% coinsurance. Is first scenario even possible? What do you suggest?

Corey Harris - August 6, 2010 6:01 PM


I am a little confused by your first question. If you have a 1 million dollar property insured by a policy with a limit of 800,000 dollars, you are insured for 20% less than the property is worth.

With a 100% coinsurance provision, the most you would be entitled to recover after applying a typical coinsurance penalty is 80% of the amount of the damages.

If you had an 80% coinsurance penalty on the 800,000 dollar policy, you would not be "under insured" as defined by the coinsurance provision. Therefore you would be able to recover the full amount of your damages, but NOT more than the 800,000 dollar policy limit.

Some policies have endorsements that allow an insured to recover beyond the limits of insurance if they actually complete the work, but these endorsements are extremely rare, especially in commercial policies. As a general rule, you may only recover up to the limit of insurance designated in the policy (800,000 dollars in your scenario).

As far as the prices for insurance goes, it is hard for me to give you specific information as I am not an agent and am not involved in the underwriting side of the industry. I can, however, tell you that the higher the coinsurance percentage is, the less expensive the policy generally becomes. Insurers count on that they will either be paid a higher amount on a policy with a higher limit, or will be able to deduct a percentage of the recovery if a policyholder has not properly insured the building.

Thanks for your comment.

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