Coinsurance clauses are commonly found in a Builder's Risk Completed Value policy. As the name suggests, a coinsurance clause makes the policyholder a co-insurer of the risk, so certain conditions can reduce the insurer's payment and leave the policyholder to cover the remainder.
Those unfamiliar with such a clause may wonder why a policyholder would accept it. The main benefit is usually lower premiums compared with similar policies that lack a coinsurance clause. That said, anyone considering a coinsurance clause should understand what it requires so they are not surprised by penalties after a loss.
A typical coinsurance clause in a Builder's Risk Completed Value policy will say the insurer will not pay more for any loss than the proportion that the limit of insurance bears to the value of the structure described in the declarations as of the structure's date of completion. For examples of builders risk coverage in specific markets, see Mexico Builders Risk (Course-of-Construction) Insurance.
The way a coinsurance clause interacts with the policy limit is often confusing. For example, a $20,000 loss with a $100,000 policy limit might appear fully covered on the surface. However, the insurer's payment can be reduced if the policyholder did not maintain enough insurance to meet the coinsurance requirement.
If the coinsurance is applied, it might look something like this. Using the $100,000 policy and $20,000 damage example, suppose the completed value of the project is determined to be $120,000 at the time of loss. The policy limit is only 80% of the completed value, so the insurer would pay 80% of the $20,000 loss—$16,000. Situations like this are a common reason to review options such as Coinsurance Deficiency Coverage.
Any time the policyholder receives less than the full amount of a claim because of a shortfall between the completed value and the policy limit, that difference is called a coinsurance penalty. These penalties often result from reporting or calculation mistakes, not from obscure policy language.
Policyholders commonly fail to report when expected costs exceed original estimates. Any increase in the completed value must be reflected in the policy limit when costs overrun initial figures. The best way to make sure the policy limit is updated is to talk to your agent so the appropriate changes can be made.
Another frequent mistake is basing the limit of insurance solely on the construction loan amount. Often the completed value exceeds the loan amount—for example, when part of the project is funded with cash that isn't included in the financed total. If insurance covers only the financed amount, the policyholder may face a coinsurance penalty.
Failing to include profit and overhead in the completed value is another source of penalties; these are commonly estimated at about 10% each. Conversely, including items that shouldn't be in the completed value—such as land value, excavations, and underground work—can cause problems because those items are typically not covered losses on standard forms.
Frequently Asked Questions
What is a coinsurance clause?
A coinsurance clause requires the insured to carry a specified percentage of the property's value in insurance, or else the insurer's payment is proportionally reduced at loss.
How is a coinsurance penalty calculated?
It is typically calculated as the ratio of the policy limit to the actual completed value, multiplied by the amount of loss.
How can I avoid a coinsurance penalty?
Keep your insurer or agent informed of cost overruns and update the policy limit to reflect the current completed value.
Should I include profit and overhead in the completed value?
Yes; profit and overhead are commonly included (often estimated around 10% each) because excluding them can lead to a significant coinsurance penalty.