Commercial property insurance topic has plenty of quite strange terms of which policyholders may find difficulties to understand unless their agents simplify the definitions. One of the most common terms used is Coinsurance, a type of penalty that applies in case policyholders fail to purchase adequate amount of coverage to cover losses.

Insurance to value ratio

Insurance company will be basically pleased to offer you a complete range of coverage, whether you need it or not. You may think insurers exaggerate the possible risk of business property losses, but it is important for you to understand that you need to purchase adequate limit of insurance equal to the actual value of insured property. For example, if you have a small office worth a replacement cost of $1 million, and you purchase a coverage limit of $1 million, the Insurance to value ratio is 100%.

You may think that it is not probably necessary to purchase 100% insurance to value ratio. In case of a fire breaks, for example, the actual replacement cost of damaged property will not reach the entire value of the building. With proper preventive equipment, the damage will be minimal. This is true, and it comes to mind that maybe you can get away by purchasing less expensive coverage limit. It is, however, not allowed.

The main reason of purchasing insurance is to cover biggest possible losses, such as total destruction of a business property building. If that happens, the insurance payout should be enough to keep your business running without spending your own money. Another reason is that insurance company also needs the money to run the business. If all policyholders only purchase, let’s say, 50% insurance to value ratio, insurers will find difficulties to cover all possible losses.

Underinsured Property

Coinsurance penalty is created to encourage policyholders to purchase high insurance to value ratio (usually 80% to 90%). This penalty policy is applied to commercial property insurance for either replacement cost or actual value of the business property.

Coinsurance imposes penalty for any underinsured property. Insurers will compare the limit of your coverage stated on the policy to the amount of insurance required for total replacement or actual value of the property. If it turns out the ratio is less than required, the penalty applies.

Information about coinsurance is usually listed on the policy under Conditions section. Almost all commercial property insurance policy provides the information, but it does not necessarily mean that you policy actually implements coinsurance rule. The rule only applies if coinsurance percentage is shown in the declaration section.