By: Greg Barcomb
In almost every profession there are certain “buzz words” or phrases that everyone hears or uses on an almost daily basis. Most of the time they involve some crucial aspect of the business and seem to spark endless debates amongst colleagues. In the world of insurance one of the biggest “buzz words” is Co- Insurance.
For the purpose of this blog we won’t get into the meaning of co-insurance as it pertains to health insurance. We will discuss co-insurance relative to how it impacts property insurance.
I am sure you as the Average Joe homeowner or commercial property policy holder have at some point heard the term co-insurance. Hopefully it was by a professional agent who took the time to explain the complicated and very important policy provision to you in a way you understand. Or maybe it was breezed over and described to you in a manner in which the person just assumed you knew what they were talking about. More than likely it was described somewhere in between these two scenarios.
So why is co-insurance so important? What’s the big deal? Here’s why: Insurance policies are promises by an insurance company to indemnify (make whole) a person or business after they suffer a loss…..IF the person or business adheres to the provisions of the policy. If the Co-Insurance Provision is not met- you, the insured, will not get the MONEY you expected following a loss. And as I’ve mentioned before, there is no worse time to be arguing the details and provisions of an insurance policy with the insurance company than after a loss.
Co-insurance is the insurance company’s answer to make sure policy holders insure the building to its full value, or within a certain percentage of full value. Insurance rates are actuarially developed based on knowing and insuring things for their correct replacement value. From the insurance company’s perspective they have to have some assurances that the insured values are correct so this is where the co-insurance provisions come into play.
For example, let’s say I own a 50,000 square foot warehouse with a full replacement cost of $1.5 million (which is NOT the same as purchase price). I say to myself; my building is literally right next door to a firehouse… there is a really slim chance of my building suffering a total loss, so why bother carrying a $1.5 million limit? Money is tight right now so I’ll only insure the building for $750,000 to keep the premium down. Sounds fair enough, right?? I go online, click a few buttons, call an 800 number and get my policy for $750,000 in property coverage nice and cheap.
The next month an employee leaves a machine running too long and it overheats and starts a fire. Our internal procedures spring into action and the fire department responds quickly and I suffer only a $100,000 partial loss to the building. Perfect! I have plenty of limit in my $750,000 policy so I should be fully indemnified (less whatever deductible I have)….right??! Wrong. In comes the Co-Insurance Provision. Think simple terms: What DID I insure for? What SHOULD I have insured for? If that % does not fall within the required co-insurance limit of the policy (normally 80, 90, or 100%) you will only be paid the % you carried of the covered loss or what is called a “co-insurance penalty”. So let’s say my policy had a 100% Co-Insurance requirement.
What DID I insure for: $750,000
What SHOULD I have insured for: $1.5 million
Because I only insured the property for 50% of value, the Co-Insurance Penalty will be in play and I will only be paid 50% of the covered loss. So what I thought was a slick move on saving some money, cost me $50,000 out of pocket.
The financial impact of this seemingly simple and harmless error made at the policies inception can be devastating. The purpose of writing this blog isn’t to try and scare policyholders into buying higher limits, but to take a minute to fully understand that this all too common example is completely and easily avoidable if the program is set up properly. Insurance policies are things no one ever wants to use, and I completely understand that. But when a claim happens don’t you want the policy to respond the way you hope and expect it to? As a mentor once told me “It so much easier to take the time to do it right the first time. If not, you’ll have to make the time to fix it later”.