Monthly Archives: May 2017

Property Valuations & Coinsurance

Property valuation. An important necessity for many reasons, including: real estate financing, listing real estate for sale, investment analysis, property insurance and the taxation of real estate. You may not think a lot about it, but it is important for agents to attain proper valuations in order to make certain their clients have adequate coverage in place at the time of loss. If not, they could be faced with what is called a coinsurance penalty – when the insured receives less money from a claim than what the property is worth.

For the purposes of this article, we’re going to spend the bulk of our time on the coinsurance aspect of property insurance.

The following is an adapted version of an article written by William Austin, principal, Austin & Stanovich Risk Managers, LLC, with some good examples of different property coinsurance scenarios to help shed some light on the subject and how it could impact your clients.

Property Insurance: Coinsurance

Pop quiz. Answer true or false to the following statements:

  • Coinsurance is a condition that may be found in more than one type of insurance policy.
  • The need for a coinsurance provision in all insurance policies is the same.
  • The use of a coinsurance provision in an insurance policy is universally understood.

The answers are true, false, and false. How did you do?

Coinsurance clauses are found in many insurance policies, such as commercial property, dwelling forms, homeowners, federal flood, health insurance, and at times even directors and officers liability policies. But, while the clause or requirement is called “coinsurance” in each type of policy, the use and effect on the insured may be very different. The coinsurance requirement in a property insurance policy may become a significant reason for insurance recovery that is less than the insured expected.

COINSURANCE CONCEPT

Coinsurance in property insurance is a means for insurers to obtain rate and premium equality. Property insurers must have a standard in which to apply expected losses based on past loss experience over an entire underwriting book. This is accomplished by getting the exposure base (total insured value for building, contents, and business income) on a common basis for all property insurance insureds: replacement cost, actual cash value, and actual loss sustained. Rates are applied against a specified percentage (100, 90, or 80 percent, for example) of the value to the insured: building, contents, or business income. Rate deviations are applied against the base (manual) rate to reflect size of deductible, construction, occupancy, and loss control standards.

A “coinsurance” condition in a property insurance policy is analogous to the need for a standard definition of “payroll” to compute workers compensation premium. All workers compensation insurers use the same “payroll” definition established by workers compensation rating bureaus such as the National Council on Compensation Insurance. This way, all workers compensation insureds report their insurable exposure (payroll) on the same basis. This allows an insurer to start its premium rating basis on an equal basis for all of its insureds—expected losses can be applied to develop a payroll rate. Rate deviations are then applied to reflect deductible (if any), premium discount, and other factors, including adequacy of loss control (rate credit or debit).

HOW IT WORKS

Property coinsurance clauses may differ by insurer, especially if using an independently filed policy form, although coverage intent may be the same. The examples used in this article are based on current Insurance Services Office, Inc. (ISO), policy forms. The reader is cautioned to read the property insurance policy to ensure that the coinsurance clause is the same as that expected and understood by the insured and the broker/agent.

DIRECT DAMAGE: COMMERCIAL INSURANCE

First, the insured must set the direct damage coverage limit, which is based on how loss is to be settled: replacement cost or actual cash value (replacement cost less depreciation equals actual cash value). Next, the coinsurance percentage for building and contents must be determined since coinsurance requirements start at 100 percent and provide the greatest rate credit at this percentage of limit to value, but the insurer may allow the insured to go as low as 80 percent. The best ways to establish insurable value is by use of a recent appraisal or by use of a construction cost estimator such as Marshall & Swift/Boeckh. It is important to get a firm value on the building and contents. A “guestimate” process may not provide the accuracy needed to establish credible value and the insured limit, which may result in a coinsurance penalty, as will be explained later.

To settle a loss, the insurer will compare the policy limit (depending on the actual policy, it may be a location-specific limit for building or contents) to the minimum limit required by the coinsurance clause.

The formula is fairly simple.

Figure 1: Loss Recovery Formula

Chances are most tree trimming services will have a special vehicle along with tree trimming equipment and tools. Any business that owns or operates a vehicle for commercial purposes should invest in commercial auto insurance. This type of insurance can protect clients from a lawsuit or medical liability if their company vehicle is involved in an accident. Along with commercial automotive insurance, the right equipment insurance can help ensure that the business will be able to continue operations even if it needs to repair or replace equipment.

Example: Direct Damage

An insured owns a 25,000 square foot building that is 10 years old. He asks the builder to give him an estimate of what it would cost in 2012 to build the same structure from the ground up. He is told $80/square foot for total estimated replacement cost of $2 million. He decides to insure the building to 90 percent of its estimated replacement cost value.

Scenario 1. A few months into the policy year, the building suffers a substantial fire loss, and the insured files a claim for $800,000. What is the insurance recovery after a $5,000 deductible?

Scenario 2. The insured decided at each renewal since 2012 that his building can remain insured for $2 million. The loss settlement clause remains replacement cost. The insured does not seek any independent counsel on the building’s estimated replacement cost in 2016. The building is damaged by fire in mid-2016, and repairs total $500,000. The replacement cost of the building is determined to be $2.4 million. What is the insurance recovery after a $5,000 deductible?

Scenario 3. The insured decided at each renewal since 2012 that his building can remain insured for $2 million. The loss settlement clause remains replacement cost. The insured does not seek any independent counsel on the building’s estimated replacement cost in 2016. The building has a fire in mid-2016, and the building is a total loss. The replacement cost of the building is determined to be $2.4 million. What is the insurance recovery after a $5,000 deductible?

In our next blog, we’ll pick-up Austin’s article as he dives into business income commercial insurance and a couple of other specialty areas including coinsurance tools.

In the meantime, if you have questions or would like to submit a submission, send a message to info@uigusa.com or call 800.385.9978.

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