Coinsurance Formula for Home Insurance: Definition, Examples (2024)

What Is the Coinsurance Formula?

The coinsurance formula is thehomeowner's insurance formula that determines the amount of reimbursem*nt that a homeowner will receive from a claim. The coinsurance formula becomes effective when a homeowner fails to maintain coverage of at least 80%of the home's replacement value. Those who are in this situation who file a claim will only receive partial reimbursem*nt according to the formula.

How the Coinsurance Formula Works

The coinsurance formula is relatively simple. Begin by dividing the actual amount of coverage on the house by the amount that should have been carried (80% of the replacement value). Then, multiply this amount by the amount of the loss, and this will give you the amount of the reimbursem*nt.If this reimbursem*nt value is greater than the specified limits of a single insurance company, a secondary coinsurer will supply the remaining funds.

Coinsurance is a clause used in insurance contracts by insurance companies on property insurance policiessuch as buildings. This clause ensurespolicyholders insure their property to an appropriate value and that the insurer receives a fair premium for the risk. Coinsurance is usually expressed as a percentage. Most coinsuranceclauses require policyholders to insure to 80, 90, or 100%of a property's actual value. For instance, a building valued at $1,000,000 replacement value with a coinsurance clause of 90%must be insured for no less than $900,000. The same building with an 80%coinsurance clause must be insured for no less than $800,000.

Real-World Use of the Coinsurance Formula

If a property ownerinsures for less than the amountrequired by the coinsurance clause, they are essentially agreeing to retain part of the risk. Thus, they becomea "co-insurer"and will share the loss with the insurance company according to the coinsurance formula.

Here are two examples that demonstrate how the coinsuranceclause works:

Building Value $1,000,000
Coinsurance Requirement 90%
Required Amount of Insurance $900,000
Actual Amount of Insurance $600,000
Amount of Loss $300,000

The coinsurance formula is:
(Actual Amount of Insurance)XAmount of Loss = Amount of Claim
(Required Amount of Insurance)

Inserting the amounts above in the formula produces the following calculation:
($600,000)X$300,000=$200,000
($900,000)

So, in this situation, the owner absorbs a $100,000 coinsurance penalty since they retained one-third of the riskrather than transfer it to the insurer. Therefore, the ownerabsorbs one-third of the loss.If the building had been insured to the amount required by thecoinsurance clause (in this case, 90%),the coinsurance calculation would look like this:

(Actual Amount of Insurance)XAmount of Loss = Amount of Claim
(Required Amount of Insurance)

($900,000)X$300,000=$300,000
($900,000)

In the second example, since the owner met the coinsurance requirement, they are not a co-insurer, and the claim is paid without penalty.

Coinsurance clauses are also found in business interruption policies. These clauses ensure that policyholders insure their revenue stream to an appropriate value.