The coinsurance section of a policy gives an insurance company the right to penalize a policyholder by reducing the amount of a claim payment in the event the amount of insurance purchased is inadequate.  In most policies, the standard amount of insurance that must be purchased is equal to 80% of the replacement value of the property.  This percentage is referred to as the coinsurance percentage.

The intent of the coinsurance penalty is to encourage clients to buy and maintain adequate insurance by penalizing them when they experience a loss and aren’t carrying adequate coverage. If it weren’t for coinsurance penalties, some policyholders would reduce their premiums and insure their property for only a portion of its value.

Sounds like a good idea until they experience a catastrophic event without enough insurance to cover the loss.

This potential situation leaves your policyholder – and you – open to risks. What should you do to mitigate these risks?

Confirm: Confirm that your client understands the coinsurance penalty and what will happen if they experience loss. Walk them through the scenarios and insist they provide backup documentation (such as a lease or appraisals) to ensure they are adequately covered. Be wary of a client that is unable or unwilling to provide this information. An attempt to save on premiums in the short-run results in greater risk over time.

Reconfirm: Check-in on a regular basis to see what has changed on your client’s side. If they are growing, the chances they add equipment and make improvements is high. Are they located in an area that is experiencing a significant increase (or decrease) in value? If so, the policy must be reworked to represent this change. Has the ownership of the building or the makeup of the products and services offered changed? A general conversation about the business uncovers areas to consider and is a good practice to stay up to date both as a way to protect the relationship and to identify areas of potential opportunity for both of you to suggest new products or modifications to existing coverage.

Consider Value Reporting: If your client’s business property fluctuates (e.g. a beach resort where values rise during the summer), they may avoid triggering the coinsurance clause in a policy through value reporting. After paying a deposit premium, your client must submit property value reports at specific intervals. Keep in mind, this only applies to personal property.

Why is this important to you?

You Can Be Held Liable: When bad things happen, the policyholder or other interested party may look to you to recover losses.

A recent case in South Carolina involved a lawsuit against an insurance agency when, at the direction of the tenant, inadequate insurance was taken out on a retail location within a building. A fire resulted in a loss without enough coverage and the building owner included the agency in the lawsuit to recover their losses. Luckily the agency had adequate records of conversations and correspondence to prove their case. Requesting backup information at the onset and confirmation of the policy would prevent this scenario.

The coinsurance penalty is in place to protect all parties and ensure that insurance coverage is established and maintained at adequate levels. Educating your client about this important clause and walking them through the ramifications of noncompliance is part of maintaining your trusted advisor relationship.