What Is the Coinsurance Formula?

The coinsurance formula is the homeowner's insurance formula that determines the amount of reimbursement that a homeowner will receive from a claim. The coinsurance formula becomes effective when a homeowner fails to maintain coverage of at least 80% of the home's replacement value. Those who are in this situation who file a claim will only receive partial reimbursement according to the formula.

Key Takeaways:

  • The coinsurance formula determines the amount of reimbursement that a homeowner or property owner will receive from a claim.
  • The coinsurance formula is applied when a property owner fails to maintain coverage of at least 80% of the home's replacement value.
  • If a property owner insures for less than the amount required by the coinsurance clause, they are essentially agreeing to retain part of the risk.
  • In this case, the owner becomes a "co-insurer" and will share any loss with the insurance company according to the coinsurance formula.

How the Coinsurance Formula Works

The coinsurance formula is relatively simple. Begin by dividing the actual amount of coverage on the house by the amount that should have been carried (80% of the replacement value). Then, multiply this amount by the amount of the loss, and this will give you the amount of the reimbursement. If this reimbursement value is greater than the specified limits of a single insurance company, a secondary coinsurer will supply the remaining funds.

Coinsurance is a clause used in insurance contracts by insurance companies on property insurance policies such as buildings. This clause ensures policyholders insure their property to an appropriate value and that the insurer receives a fair premium for the risk. Coinsurance is usually expressed as a percentage. Most coinsurance clauses require policyholders to insure to 80, 90, or 100% of a property's actual value. For instance, a building valued at $1,000,000 replacement value with a coinsurance clause of 90% must be insured for no less than $900,000. The same building with an 80% coinsurance clause must be insured for no less than $800,000.

If a property owner insures a property for less than the amount required by the coinsurance clause, they become a "co-insurer" and will share the loss with the insurance company.

Real-World Use of the Coinsurance Formula

If a property owner insures for less than the amount required by the coinsurance clause, they are essentially agreeing to retain part of the risk. Thus, they become a "co-insurer" and will share the loss with the insurance company according to the coinsurance formula.

Here are two examples that demonstrate how the coinsurance clause works:

Building Value $1,000,000
Coinsurance Requirement 90%
Required Amount of Insurance $900,000
Actual Amount of Insurance $600,000
Amount of Loss $300,000

The coinsurance formula is:
(Actual Amount of Insurance )     X    Amount of Loss = Amount of Claim
(Required Amount of Insurance)

Inserting the amounts above in the formula produces the following calculation:
($600,000)   X   $300,000  =  $200,000
($900,000)

So, in this situation, the owner absorbs a $100,000 coinsurance penalty since they retained one-third of the risk rather than transfer it to the insurer. Therefore, the owner absorbs one-third of the loss. If the building had been insured to the amount required by the coinsurance clause (in this case, 90%), the coinsurance calculation would look like this:

(Actual Amount of Insurance)    X  Amount of Loss = Amount of Claim
(Required Amount of Insurance)

($900,000)  X  $300,000  =  $300,000
($900,000)

In the second example, since the owner met the coinsurance requirement, they are not a co-insurer, and the claim is paid without penalty.

Coinsurance clauses are also found in business interruption policies. These clauses ensure that policyholders insure their revenue stream to an appropriate value.