Monday, July 15, 2013

Co-insurance At Work Made Easy

Co-insurance is an often-complicated under-insurance condition in which you specify a sum insured for each separate item of property.

Commonly, it is seen as a sharing of risk between the insurer and the insured should a claim arise, the two will be required to share costs after a deductible is met.

Put simply, if you insure something for less than 80% of its full value you may have to pay some of the costs towards the loss of the item.  This only applies if the loss exceeds 5% of the total declared value.

Here's an example of co-insurance at work:

The customer in our example story had their commercial building insured for around $14,350 when extensive damage was done to it during Cyclone Larry.  Repair quotations were sought and the repair costs totalled $45,000 and our assessor used industry guidelines to estimate the cost of rebuilding this structure at $261,540.

The customer's building was only insured for around 5% of its actual value.  In this instance, as the insured had covered their building for less than 85% of the actual value, the co-insurance clause applied—this meant that the customer was paid less than $1,000 towards their repairs.

Now that's disturbing!

A more detailed explanation:

Let's say you have a building that you believe would cost $100,000 to replace and a co-insurance penalty in your policy of 80%. You insure the building for $80,000 (80%) thinking you have fulfilled the co-insurance clause. A fire causes $60,000 worth of damage to your building and you submit a claim. Your insurance company subsequently determines that the replacement cost of the building is actually $150,000.

To determine how much to pay on the claim, the insurer uses the following formula:

Sum insured                x          amount of damage     = amount payable by insurer

80% of full value

Basically, the insurer divides the amount of insurance you purchased ($80,000) by the amount you should have purchased (80%of $150,000 or $120,000). The result (two-thirds, or $40,000) is the amount the insurer will pay.

If the building had been insured for at least $120,000, the insurer would have reimbursed you for the full amount of the loss. Co-insurance can be tricky and cost you a ton of money if you under-insure your property.

If we use the above figures again, in the event of a total loss ($150,000), the insurer's liability is limited to the sum insured of $80,000 and this is the amount that would be paid.  The client (which could be you) therefore has to wear the balance - in this case, the uninsured loss of $70,000 ($150,000 - $80,000).
When the under-insurance condition is applied, the value of the property is assessed at the time when the contract of insurance was entered into or last renewed, extended, or varied.

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