The Importance of Coinsurance in Property Adjusting
For any aspiring public adjuster, understanding the coinsurance penalty is not just a requirement for the complete Public Adjuster exam guide; it is a fundamental skill used in daily claim settlement. Coinsurance is a provision in property insurance policies that requires the policyholder to carry insurance equal to a specific percentage of the total value of the property.
The primary purpose of this clause is to encourage policyholders to insure their property to value. Most partial losses are more frequent than total losses. Without a coinsurance clause, policyholders might be tempted to buy only enough insurance to cover a partial loss, leaving the insurer with insufficient premiums to cover the actual risk exposure. When a policyholder fails to meet this requirement, they become a "co-insurer" and must share in the loss, resulting in a penalty.
The Four Pillars of the Coinsurance Calculation
The Mathematical Formula: Did Over Should
The standard formula used by adjusters to determine the payout when a coinsurance penalty applies is often referred to as the "Did over Should" formula. It is calculated as follows:
- Step 1: Determine the "Should." Multiply the Replacement Cost Value (RCV) of the property at the time of loss by the coinsurance percentage (usually 80%, 90%, or 100%).
- Step 2: Compare "Did" to "Should." If the "Did" (the actual policy limit) is less than the "Should," a penalty applies.
- Step 3: Apply the Ratio. Divide the amount of insurance carried by the amount of insurance required.
- Step 4: Multiply by the Loss. Multiply the resulting fraction by the amount of the loss.
- Step 5: Subtract the Deductible. The deductible is applied after the coinsurance penalty calculation.
The formal equation looks like this: (Amount Carried / Amount Required) x Loss Amount = Payout (subject to policy limits).
Exam Tip: The Deductible Sequence
On the Public Adjuster exam, pay close attention to the order of operations. Many candidates mistakenly subtract the deductible from the total loss before applying the coinsurance ratio. In standard ISO forms, you apply the penalty first, then subtract the deductible from the resulting figure. Always check practice Public Adjuster questions to refine this specific calculation sequence.
Scenario Comparison: Full Coverage vs. Underinsured
| Feature | Adequate Coverage (80%) | Underinsured (Penalty Applied) |
|---|---|---|
| Property Value (RCV) | $500,000 | $500,000 |
| Required Insurance | $400,000 | $400,000 |
| Actual Limit (Did) | $400,000 | $200,000 |
| Loss Amount | $100,000 | $100,000 |
| Final Payout | $100,000 (minus ded.) | $50,000 (minus ded.) |
Step-by-Step Case Study
Let's walk through a complex example that you might encounter on the exam. Imagine a commercial building with a Replacement Cost Value of $1,000,000. The policy contains an 80% coinsurance clause and a $1,000 deductible. The building owner carries a limit of $600,000. A fire causes $200,000 in damage.
- Calculate the "Should": $1,000,000 x 0.80 = $800,000.
- Establish the Ratio: The owner carried $600,000 (Did) but should have carried $800,000 (Should). The ratio is 600,000 / 800,000, or 0.75 (75%).
- Apply the Ratio to the Loss: $200,000 x 0.75 = $150,000.
- Subtract the Deductible: $150,000 - $1,000 = $149,000.
In this scenario, the building owner suffers a $51,000 penalty ($50,000 from coinsurance and $1,000 from the deductible) because they were underinsured by $200,000 relative to the required limit.
Frequently Asked Questions
Technically, the formula is applied, but because the payout cannot exceed the policy limit, the result for a total loss is usually the limit of insurance itself. However, the policyholder still suffers because the limit is far below the actual value of the property.
Policyholders can avoid the penalty by maintaining limits at or above the required percentage (e.g., 80% or 90%) or by adding an Agreed Value Optional Coverage endorsement, which suspends the coinsurance clause for the policy term.
Coinsurance is calculated based on the value of the property at the time of loss. If inflation or renovations increase the building's value, the policyholder must increase their limits to stay compliant with the coinsurance percentage.
This depends on the policy's valuation basis. If the policy is written on an RCV basis, the 'Should' is calculated using the Replacement Cost. If it is an ACV policy, the 'Should' is based on the Actual Cash Value.