Understanding the Coinsurance Clause
In the world of property insurance, the coinsurance clause is a provision that requires a policyholder to carry a specific amount of insurance, usually expressed as a percentage of the property's total value. For most homeowners policies (such as the HO-2, HO-3, and HO-5), this requirement is typically 80% of the replacement cost of the dwelling.
The purpose of this clause is to encourage homeowners to insure their property to its full value. Because most insurance claims are partial losses rather than total losses, many homeowners might be tempted to purchase only enough insurance to cover a small fire or a localized storm. This creates an imbalance for the insurance company, which collects lower premiums while still paying out the bulk of most claims. To learn how this fits into the broader scope of policy provisions, check out our complete Homeowners exam guide.
The Golden Rule: The 'Did over Should' Formula
When calculating a loss settlement under a coinsurance penalty, the formula is: (Amount Carried / Amount Required) x Loss = Amount Paid.
Students often remember this as the "Did over Should" formula: (What you did carry divided by what you should have carried) multiplied by the amount of the loss.
Key Variables in the Calculation
Step-by-Step Calculation Example
To master the coinsurance penalty for the exam, you must be able to walk through a mathematical scenario. Consider the following example:
- Replacement Cost of Home: $500,000
- Coinsurance Requirement: 80%
- Insurance Carried: $300,000
- Amount of Loss: $100,000
Step 1: Determine the "Should" amount. Multiply the replacement cost by the coinsurance percentage. ($500,000 x 0.80 = $400,000). The homeowner should have carried $400,000.
Step 2: Apply the "Did over Should" ratio. Divide the carried amount by the required amount. ($300,000 / $400,000 = 0.75 or 75%).
Step 3: Calculate the payout. Multiply the ratio by the loss. (0.75 x $100,000 = $75,000). In this scenario, the insurance company will pay $75,000, and the homeowner must pay the remaining $25,000 as a penalty for being underinsured.
Impact of Underinsurance vs. Full Insurance
| Feature | Scenario | Insured Amount | Loss Amount | Claim Payout |
|---|---|---|---|---|
| Adequately Insured (80% or higher) | $400,000 | $50,000 | $50,000 (Full Payout) | |
| Underinsured (Penalty applies) | $200,000 | $50,000 | $25,000 (50% Penalty) |
Important Exam Nuances
There are a few specific rules you must remember for the Property & Casualty exam regarding coinsurance:
- Total Losses: The coinsurance penalty generally only applies to partial losses. If a home is a total loss, the insurance company will simply pay the limit of liability stated on the policy.
- Deductibles: In most exam questions, the deductible is subtracted after the coinsurance calculation is performed. However, always read the question carefully to see if it specifies otherwise.
- Valuation: Coinsurance is based on Replacement Cost at the time of the loss, not the market value or the purchase price of the home.
To test your knowledge on these nuances, visit our practice Homeowners questions.
Frequently Asked Questions
If you meet the 80% requirement, no coinsurance penalty is applied. Partial losses are paid at 100% of the replacement cost, up to the policy limits (minus the deductible).
No. Coinsurance calculations are based only on the replacement cost of the structure. Land does not burn or blow away, so its value is excluded from the calculation.
No. A deductible is a fixed dollar amount the insured pays on every claim. A coinsurance penalty is a reduction in the claim payout that only occurs if the insured failed to maintain adequate coverage limits relative to the home's value.
The 80% threshold allows for slight fluctuations in construction costs and inflation without immediately penalizing the homeowner for being slightly underinsured.