The Often-Misunderstood Insurance Clause That Could Cost You $20,000 (Or More)

The co-insurance clause in your building policy is one of the most misunderstood features among apartment building owners – and not understanding it could cost you tens of thousands of dollars. This article is designed to help you determine whether you may have made an error in calculating your coverage, and save you from a costly out-of-pocket payment that could disrupt or even bankrupt your business.

Please note: this article is only designed to help you understand the way co-insurance works and show that many people miscalculate their coverage in a way that leaves them open to out-of-pocket costs. If you see that you’ve made the mistakes we describe here, then you may not have the coverage you need. We can’t determine exactly what an “appropriate” amount of coverage would be for you through this article, however – to do that, you’ll need to consult with your policy advisor and make your own best judgment.

Most people first encounter the term “coinsurance” when they get their first health insurance policy, and thus feel they have a basis for understanding the coinsurance required by Property/Casualty Insurance. Unfortunately, though they share the same name, the two types of coinsurance offer completely different coverage – and the difference could be a shockingly unwelcome fee in your business proceedings.

In health insurance, an 80% coinsurance would mean that the insurance company will cover 80% of the claim, while you would be responsible for 20% – up to the limit of your deductible. If your deductible was $1,000 and your hospital bill was $1,000, then your insurance company would be responsible for 80% ($800) and you would be responsible for 20% ($200), because you would not have reached the limit of your deductible. If the hospital bill was for $10,000, then 20% of the bill would be $2,000, but since that amount is more than your deductible, you are only liable for the limit of your deductible: $1,000, while the insurance company covers the remaining $9,000.

Which is why many people, when they know they have Property/Casualty Insurance coverage with a Building Limit of $1,000,000, coinsurance of 80%, and a property deductible of $1,000, assume that the most they will ever have to pay is the deductible: $1,000.

This is not the case with Property/Casualty Insurance, where the co-insurance claim might better be thought of as an “honesty clause.” It is designed to prevent business owners from under-insuring their buildings by penalizing you if your projected “building limit” turns out to be inaccurate.

Let’s say you have the above policy:

Building limit: $1,000,000

Co-insurance: 80%

Property deductible: $1,000

A tenant starts an electrical fire in your building, causing $125,000 of smoke and fire damage. To you, this looks like it’s completely manageable with your claim. After all, you’re covered up to a million dollars, and your deductible is only $1,000, which you can easily afford to cover. You’re in the clear, right?

Unfortunately, no. The claims personnel settling the loss will run their own estimate of the cost to replace the entire building the way it was (this is the “building limit” in your policy) and if their assessment differs from yours, your co-insurance clause kicks in, drastically increasing the amount you are required to cover yourself.

Let’s say that their estimate for the building limit is $1,500,000, while yours was only $1,000,000. You decided to go with the 80% coverage option, so the co-insurance clause adjusts the amount you will receive this way:

(Your Building Limit ÷ 80% of their Building Limit x Claim Amount) – Deductible = Amount Covered By Insurance

Plugging in the numbers from our scenario, this would mean:

$1,000,000 ÷ (.80 x $1,500,000) x $125,000) – $1,000 = $103,166

You will only receive $103,166 of your $125,000 claim, leaving you with $19,833 to cover out of pocket – plus your deductible of $1,000, bringing your total to $20,833. Much more than you had planned on; you had thought you’d only need to set aside that $1,000 deductible.

How does this discrepancy occur?

Frankly, many owners are looking at the immediate costs of the insurance when they sign the forms. If it costs less to insure their building at $1M instead of $1.5M, then they’re happy to accept an appraisal that values their building at the lower number – not realizing that an accurate valuation is critical to keeping their costs low when they have to put in a claim.

By the same token, you have to take a coinsurance of 80% or higher; you can choose a coinsurance of 90% or 100% for more complete coverage, but most people choose the lowest possible coinsurance to keep costs low.

Let’s say you took the minimum option of 80%, and you have a building that one estimate says is worth 1 million dollars. However, another estimate says it’s only worth $500,000 dollars, and so, hoping to keep your insurance costs low, you took the second appraiser’s appraisal and insured your building for 80% of that worth: $400,000.

You put in a claim for $100,000 because of damage caused by faulty wiring – which is when it comes to light that the insurance company’s appraiser agrees with the first one you consulted: the building’s true value is $1,000,000, and you will now be penalized for the discrepancy.

Since you only insured your building , your claim will be chopped in half.

Thankfully, by working with your claims adjuster, you can actually find out with a fair degree of accuracy how much a claims adjuster would conclude your building is worth. You’ll need to determine:

  • The actual replacement cost of the building structure
  • The actual replacement cost of the equipment and inventory
  • The actual cash value of the same property
  • The true business interruption value, accounting for growth

But this means you must listen to your insurance agent and be willing to look at the value of your business from the perspective of the claims personnel called in to settle a loss.

To determine the correct value of your building and avoid this common problem, we recommend getting multiple bids from contractors who specialize in building the same sort of property you have. That data can give you better idea of the true cost of replacing your building. It’s important to get those values beforehand and update them regularly to keep pace with inflation – because if you wait until it’s time to file a claim, you’re likely to be caught flat-footed with too-low coverage.

You also need to consider one very important factor: the Extended Period of Indemnity Endorsement.

This coverage handles losses during the time it takes to get your business back up and running again. It will take time to find new tenants, review applications, and move them into the apartments after they are repaired, and you may have apartments sitting empty for months before you can find new tenants for them. This coverage ensures you won’t have to eat the cost of those empty apartments.

By communicating with your insurance agent, you can avoid these unexpected and unwelcome out-of-pocket expenses, and ensure your coverage is sufficient to keep your business operating for years to come – even if catastrophe strikes.