Q: What are the risks and advantages of insuring a commercial property with 100% coinsurance?

Response 1: The advantage is a lower rate. But if the limit is less than the actual value of the property, the disadvantage is that the insured is going to be penalized on just about every claim.

Response 2: As long as the limit of liability equals the actual cash value or replacement cost, there’s no risk. The advantage is a lower premium and a happier client if there is a loss. If you don’t insure the property to the correct value, the risk is that there will be a serious penalty at the time of loss.

Response 3: Add 5% additional agreed value optional coverage. That way, at the time of a loss, 100% coinsurance will generate a 10% credit.

Response 4: Don't ever do this. Yes, you should insure at 100% total insurable value, but never use 100% coinsurance on a property. What if you’re wrong at the time of the loss, which is when the value is calculated? Don't subject the insured to such an onerous condition. Insure at 100% total insurable value and use 90% coinsurance.

Response 5: The risk is that you have no cushion if your replacement cost figures are not accurate. Yes, there is a discount on the rate, but it’s better to insure for 100% of the value and use an 80% coinsurance percentage—then you have a 20% cushion. Better yet, use agreed value and suspend coinsurance.

Response 6: The risk is that it may place a high burden on the insured, leaving no room for any variance and potentially exposing them to a coinsurance penalty. On the other hand, if you use a 100% clause in conjunction with an agreed value endorsement, there is no risk except whether a sufficient amount of coverage was purchased to actually replace the property.

Response 7: The obvious risk is that at the time of loss—not application—the 100% coinsurance requirement must be met, which puts a heavy burden on the insured. The advantage is the premium savings.

Response 8: The advantage is that the rate is lower than at 90% coinsurance, or any other agreed amount. The disadvantage is that there’s no wiggle room in the property values, and it doesn’t provide the protection of an agreed amount. Basically, 100% coinsurance increases the likelihood that your client will suffer a penalty at a time of loss.

I’ve avoided 100% coinsurance for over 40 years. I’ve seen too many nasty losses and prefer to give the client better odds.

Response 9: In the case of 100% coinsurance, if a property insurance limit is lower than the value of the insured property, a proportional penalty will be assessed after a loss. A typical 80% coinsurance clause leaves more leeway for undervaluation, and thus a lower chance of a penalty in a claim situation. Insuring a property on an agreed value basis may well be a better option for some insureds as it eliminates the possibility that a coinsurance penalty will be invoked.

Response 10: I think people often elect for 100% coinsurance without considering the pros and cons. The risk of using 100% coinsurance is that at the time of the covered loss, the value of the covered property—either replacement cost or actual cash value—is greater than the limit of insurance on the property, which can occur during times of inflation in building materials.

For example, assume you set a property’s limits at $1 million with 100% coinsurance on a replacement cost basis. When the building sustains a covered $300,000 loss 11 months later, it is determined that the actual replacement cost of the building at the time of the loss is actually $1.1 million. Under the coinsurance formula—amount insured divided by the amount you should have insured, multiplied by the loss—the calculation is $1 million divided by $1.1 million, multiplied by $300,000. In this scenario, the insurer would pay $272,700 for the loss, leaving your client with a coinsurance bill to the tune of $27,300, which is obviously not good.

During times of inflationary pressure, the risk can be a real issue. We often see this phenomenon after major catastrophes, such as hurricanes and tornadoes.

The major advantage of using 100% coinsurance is lower rates. Under ISO property rules, a credit of 10% is applied to the published 80% property loss costs. It is important to remember that in the coinsurance calculation, the limit of insurance is compared to the value of the property at the time of loss, not the effective date of the policy.

Response 11: In a total loss situation, the advantage is immense. It's interesting to see people argue about deductibles on the front end and then insure buildings for 80% and 90% of their replacement cost. When they have a total loss, they are down 10-20% immediately. Then, assuming the site is not congested or obstructed, debris removal in a total loss averages 12-15% of the cost to build new. This puts the insured down 25-35% of replacement cost. If the site is congested or obstructed, debris removal may be 25-40% of replacement cost, and the policy debris removal supplement is $10,000. At this point, the insured is down 45-60%. 

Then they learn about credit risk. The lender is named in the mortgagee clause and named on the check. Lenders are required to post much larger reserves on any loan with damaged collateral, so they take insurance proceeds to pay off the loan. The insured receives the difference between the loan amount and the policy limit, which is often a very modest sum, and usually not enough to remove the debris.

Insure property for 100% of replacement cost using an agreed amount endorsement. When coverage is specific, always add increased debris removal coverage in anticipation of a total loss, as well.

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