Coinsurance Formula

The coinsurance formula is the homeowners 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.

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.

Co-insurance 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. Co-insurance is usually expressed as a percentage. Most co-insurance 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 co-insurance clause of 90 percent must be insured for no less than $900,000. The same building with an 80 percent co-insurance clause must be insured for no less than $800,000.

If a property owner insures for less than what is required by the co-insurance 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 co-insurance formula.

Here are two examples that demonstrate how the co-insurance clause works:

Building Value $1,000,000
Co-insurance Requirement 90 percent
Required Amount of Insurance $ 900,000
Actual Amount of Insurance $ 600,000
Amount of Loss $ 300,000

The co-insurance 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 co-insurance 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 co-insurance clause (in this case, 90 percent), the co-insurance 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 co-insurance requirement, he was not a co-insurer and his claim is paid without penalty.

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