What is Commercial Co-Insurance?

Understanding Commercial Co-Insurance Clauses

If you're in the market for property insurance coverage for a business property, you've probably come across the co-insurance clause that is included in most business insurance policies. Even if you think you understand it perfectly, it's worth reviewing the basics to ensure you know all the ins and outs of strictly how commercial co-insurance works.

The truth is that co-insurance is one of the most misunderstood and confusing concepts in insurance. Commercial co-insurance is a fundamental principle of business property insurance, and the qualified brokers at Morison Insurance would like to help you understand it by explaining how it works. In this article, we'll explain what commercial co-insurance is and how it's calculated, as well as answer a few common questions to help you ensure you have the proper coverage limits for your insurance needs. You know precisely what to expect when the time comes to file a claim.

Commercial Co-Insurance Explained

Commercial co-insurance is an agreement between you and the insurance company whereby you agree to maintain coverage up to a stated percentage of the value of the property you wish to insure (Usually 80% or 90%). As a result of this promise, a significant concession in the rate is given.

Should a loss occur, consideration is given to the amount of insurance carried compared to actual cash values or replacement costs prior to a loss. If the amount of insurance is within the agreed co-insurance percentage requirement, the loss is paid in full, up to the policy limits. However, if the amount of insurance you carry is below the agreed percentage, you and the insurance company share the loss.

The coverage limits on your commercial or rental properties must be adequate to protect you in the event of a financial loss due to an inaccurate property amount of insurance

How is Co-Insurance Calculated?

Commercial co-insurance can be described as the amount of insurance purchased divided by the amount required and multiplied by the amount of the loss to find the amount of the insurance claim they can receive.

For example, a commercial building with a value of $500,000 and an 80% co-insurance clause must be insured for $400,000 to meet the policy requirements. If the policyholder only purchased a coverage limit of $300,000 and suffered a $100,000 loss, the insurance company would only be required to pay $75,000 of the loss. The risk's underinsured percentage would reduce the claim payout.

Here's the above example expressed as a formula:

(Coverage Limit Purchased) ÷ (Required Coverage Limit) X (Amount of Loss) = (Payout)

$300,000 ÷ $400,000 X $100,000 = $75,000

In this example, $300,000 is the coverage limit the policyholder purchased. $400,000 is 80% of the building's value. $100,000 is the amount of the loss, and $75,000 is the amount of compensation they are eligible to receive.

Will the Policyholder Receive the Full Amount If a Loss is Less Than the Coverage Limit?

This is a crucial answer to understand because it's exactly where many policyholders get confused and cannot receive the insurance compensation they were expecting after they file a claim. It's easy to see where the misunderstanding comes in—if your loss is less than the coverage limit, you may assume that the full amount of the claim will be paid, but that's not the case with co-insurance.

In the example formula listed above, the policyholder files a claim for a $100,000 loss, which is well below their policy's $300,000 coverage limit. However, because the total value of the building is $500,000, the $300,000 coverage limit falls short of the 80% coverage limit required by the commercial co-insurance clause since 80% of $500,000 is $400,000. $300,000 divided by $400,000 is 0.75, meaning the policyholder only has 75% of the coverage limit amount they should have. The amount that the policyholder is underinsured is the amount their claim will be reduced by. As a result, they are only eligible to receive an insurance payout of 75% of the amount of the claim, or in this case, $75,000—regardless of the fact that the amount of the loss is less than the coverage limit they purchased.

Is an Appraisal Required for Commercial Co-Insurance?

Insurance companies do not require an appraisal to determine the value of a building for co-insurance. Instead, the policyholder decides how much coverage to purchase. Building owners may want to obtain a professional appraisal to determine the cost of rebuilding to ensure their coverage limits are adequate to meet the co-insurance requirement of their policy. It is generally in the policyholder's best interests to have an appraisal done to confirm the value of the building because it's the only way to rest assured that you do have adequate coverage in place and you will be able to receive the property value of your claim should you experience a loss. This is subject to all other terms of the policy and claim circumstances.

Your Morison Insurance broker has tools to calculate an approximate estimated value for your property, but it's crucial to keep in mind that it's only an approximate estimate. There may be factors at play that your broker doesn't know about and, therefore, can't account for. That's why it's much better to have a professional contractor evaluate the building and give you an estimate of its value based on how much it would cost to rebuild if it were destroyed.

Is the Value of a Building the Same as the Real Estate Purchase Cost?

You may think you know the building's value, but that's not necessarily the case. It's important to understand that the price you paid when you purchased the property is not necessarily the actual value for insurance purposes—in fact, it's typically not even close, and there are some good reasons for that. 

Real estate value is calculated based on a wide range of factors, including location, land value, and comparables, which means how many similar buildings nearby have recently been sold. Location, for example, is an extremely important consideration in a real estate valuation because, as we all know, a building in a highly desirable location will sell for a much higher price than the same building in an undesirable location.

However, the value of insurance coverage isn't concerned with the same factors. Instead, it reflects how much it would cost to rebuild the building if it was severely damaged or completely destroyed. For example, suppose the worst thing happens: a fire tears through the building, burning it down to the ground. The cost of rebuilding it as it was before would be based on the cost of the building materials, contractor labour and other similar factors. The location, land value and comparables wouldn't matter to the valuation because the land is still there—the building needs to be replaced.

That's why real estate value and valuations for the purpose of insurance coverage are almost always very different. You can't simply use the purchase value of the property to determine the value of the building when you are deciding which coverage limit to go with for your commercial co-insurance policy.

Can the Value of a Building Change Over Time?

The cost of replacing a building will always change over time. Inflation has a big effect on the cost of materials and contractor labour, so the cost of rebuilding today will be quite different in 10 years. You may also invest in renovations over the years that can increase the value of the building. Therefore, it's really important that when your insurance renewal rolls around, you take the time to consider anything you may have done to enhance the value of the building and let your Morison Insurance broker know so they can help you adjust your coverage limits.

Policyholders should also consider having an appraisal re-done every five years. Doing so will give you the peace of mind that comes with knowing you have adequate insurance coverage limits and your commercial co-insurance clause won't reduce your claim amount should you experience a loss.

Does Commercial Co-Insurance Apply Solely to Commercial Property Coverage?

A co-insurance clause may also apply to other sections of your commercial policy, such as rental income, equipment and contents. These coverages do fall under the broad category of property insurance, but they don't all pertain specifically to the building. Contents coverage, for example, is a type of property insurance that applies to the contents of the insured property that aren't a part of the building itself, such as furniture, electronics, and pretty much all the belongings or items on the property. Commercial co-insurance clauses typically apply to all the property-related coverages that are a part of your business insurance policy. 

Does Co-Insurance Only Apply to Business Insurance Policies?

We've discussed commercial co-insurance above, and business insurance policies are typically where co-insurance clauses are found. Still, home insurance policies and other types of personal insurance policies can also have co-insurance clauses. When you work with an experienced broker such as the professionals at Morison Insurance, you get the benefit of having all clauses and conditions explained clearly to you so you know exactly what to expect from your insurance coverage. If you have questions about your coverage or are looking for a certain type of insurance, call us today to speak with a qualified broker. We're happy to answer any questions you may have and offer you all the information you need to be fully informed about your insurance coverage and options, including co-insurance clauses—commercial or otherwise.

Find Out More About Commercial Co-Insurance By Calling the Experts at Morison Insurance

Are you puzzling over the meaning of a co-insurance clause in your insurance policy or looking for answers about how to ensure you have the right amount of coverage to avoid a penalty on your claim? Your friendly broker has the answers you're seeking!

If you have any questions or concerns about business insurance, coverage limits, or other commercial or personal insurance matters, contact us at Morison Insurance. We're here to help!