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 keep coverage of at least 80 percent of the home's replacement value. Those in this situation who file a claim will only receive partial reimbursement according to the formula.

How the Coinsurance Formula Works

The coinsurance formula itself 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, then 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 percent of a property's actual value. For instance, a building valued at $1,000,000 replacement value with a coinsurance clause of 90 percent must be insured for no less than $900,000. The same building with an 80 percent coinsurance clause must be insured for no less than $800,000.

Real-World Use of the Coinsurance Formula

If a property owner insures for less than what is 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 percent
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

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 percent), 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

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

Coinsurance clauses can also be found on business interruption policies where it ensures that policyholders insure their revenue stream to an appropriate value.