Coinsurance clauses are commonly found in a Builder’s Risk Completed Value policy. As one might deduce merely from the name, a coinsurance clause involves the policyholder becoming a co-insurer of the risk of loss with the insurer. In other words, certain conditions would result in the insurance company not paying the total amount of loss, thereby leaving the policyholder to bear the remainder of the loss amount. The insured and the insurer jointly assume the risk.
Those unfamiliar with such a clause are probably wondering why any policyholder would even consider a coinsurance clause. The benefit of buying an insurance policy with such a clause is that the policyholder will usually have relatively low premiums compared with similar policies that don’t contain a coinsurance clause. That said, anyone considering a coinsurance clause should understand what it entails and requires, so that they aren’t taken by surprise with penalties should a loss occur.
A typical coinsurance clause found in a Builder’s Risk Completed Value policy will say that 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.
The way a coinsurance clause works with the policy limit is often a source of confusion for policyholders. Take a loss of $20,000 with a policy limit of $100,000 for instance. It would superficially appear as though the insurer would be responsible for the total loss. However, once the coinsurance clause is figured into the equation, the insurer might not be responsible for paying the total loss amount. This will depend on the policyholder maintaining enough insurance to avoid the coinsurance penalty.
If the coinsurance is applied, it might look something like this: Still using the $100,000 policy and $20,000 worth of damage from above, the completed value of the project will be determined as $120,000 at the time of loss. The value of the $100,000 policy is only 80% of the $120,000 actual value of the project. So, the insurer is only responsible to pay $16,000, which is 80% of the $20,000 worth of damage.
Anytime the policyholder receives a lesser sum than what the full value of the claim is because of a shortfall between the completed value of the project and the policy limit, it’s termed a coinsurance penalty. The discrepancy between the two numbers can be the result of a number of mistakes made by the policyholder. Policyholders often make the mistake of failing to report when expected costs are surpassed. Any increased completed value must be shown in the policy limit when costs overrun original figures. The best way to make sure the policy limit is updated is by keeping your insurance agent apprised to the overruns so that the appropriate changes can be made.
All too often a policyholder makes the mistake of setting their limit of insurance based on the amount of the construction loan for the structure. Most of the time, the completed value of the project is greater than the amount of the construction loan. An example would be a significant portion of a building project being funded by cash, but not computing the cash amount when totaling the completed value. If the insurance is only for the financed amount, then the policyholder will suffer a coinsurance penalty for any losses.
Another common mistake occurs when the policyholder doesn’t include profit and overhead in the completed value. These are generally figured at 10% for each. If not accounted for, this can cause a substantial coinsurance penalty.
Sometimes, it’s what shouldn’t be included that could lead to problems. Land value, excavations, and underground work, for example, shouldn’t be included in the completed value. These aren’t covered losses on typical policy forms. So, the policyholder would just be paying additional costs for items that wouldn’t be covered during loss.