You may be familiar with coinsurance in terms of health insurance and workers' compensation policies. In these cases, coinsurance means both the insurance company and the patient share the costs of medical procedures. Coinsurance in business is different and relates to coverage for a small business's property and assets. Here's how coinsurance for business insurance works.
What is coinsurance for businesses?
Coinsurance clauses in small business insurance policies apply mainly to business property, including vehicles, buildings and office equipment. The coinsurance clause outlines the percentage of the property's value that a policy owner must insure to receive payment on a claim.
Why do insurance companies offer coinsurance?
With a coinsurance clause, the insurer knows you have adequate coverage if you need to make a claim. Coinsurance protects the insurance company's ability to pay out claims for policy owners, assist with underwriting, and determine insurance premiums.
The insurer applies coinsurance percentage rates to business property or business income. This percentage rate depends on the property value covered under the policy owner's plan, such as actual cash value (ACV) and replacement cost value (RCV).
Is coinsurance different from a deductible?
Coinsurance and deductibles are different things. Coinsurance is a percentage of the cost-sharing between the policy owner and the insurer. On the other hand, a deductible is a predetermined amount listed in your policy. Each time you file a claim, your insurer subtracts the amount payable to you from the deductible until the deductible amount is met or exceeded. Check your policy's declaration page for details, call your insurance agent, or ask the insurer during the process of choosing a business insurance provider if you have any questions.
How does coinsurance work on a commercial property?
Let's say an insurer requires the amount of insurance you purchase on a property to be 80% of the property's value to cover replacement costs adequately.
In this example, the insurance limit would be 80% of the property's value. If you fail to meet this required coverage amount and you file a claim on damaged property that exceeds the coverage limit, you'll face a penalty to make up for the inadequate insurance.
Check your policy for specific coinsurance percentage requirements associated with your property's value and any penalties the insurer could impose.
What is a 100% coinsurance clause?
When you're reviewing policy options, it may seem like most property insurance possibilities involve coinsurance where each party shares in a percentage of the claim. While this is a valid assumption, it's not always the case.
Under a 100% coinsurance clause, the business owner must insure 100% of the property's value. The policy's premium costs are typically lower because the insurer doesn't take on the same amount of risk as it would with an 80% policy, in which the insurer would have to pay out 20% if a claim is filed.
However, business owners should consider two things:
- You risk underinsuring the asset if it rises in value after the policy is purchased. Think of rising commodity inventories, such as coffee, or land, such as real estate.
- If the asset's value increase isn't accurately recorded (such as property that rises $100,000 to $160,000), and the property value is actually higher than the policy limit (say, at $100,000 for a 100% coinsurance clause), you could be required to pay the uninsured shortfall. In this example, that would be $60,000 (minus the deductible) if the property is entirely damaged, since the $100,000 policy covers only 70% of the $160,000 valued property. The cost of this underinsured property could outweigh premium savings under a 100% coinsurance policy.
Fortunately, there are several options for business owners who want to avoid penalties.
What is a coinsurance penalty clause?
A coinsurance penalty clause, often found on the insurance policy's declaration page, penalizes the policy owner for not sufficiently insuring the property. These clauses require you to carry a specific amount of insurance based on the value of the property being covered.
How to avoid coinsurance penalties
There are several ways policy owners can avoid coinsurance penalties.
Agreed value for business property insurance coverage
Agreed value is often a higher-priced coverage option. Under this option, you and the insurer agree on the total value of all of your physical assets or property. The limits on the policy must equal the agreed-upon value.
Agreed value specifically requires a statement of property values that you submit to the insurance company before the policy is issued or renewed each year. You must meet all stipulations defined in the policy to avoid a coinsurance penalty.
For example, if your coffee inventory stock would currently cost $2,000 to replace, you must insure for at least 100% of the agreed value at $2,000 to avoid a shortfall and a coinsurance penalty if your inventory (commodity price) rises in value at the time of loss.
This is the formula for agreed value:
Percentage of coinsurance x Estimated net income and expenses for the time period specified by the insurer = Agreed value
Agreed value for business income insurance
Agreed value for business income insurance works similarly to agreed value in property insurance. However, in this case, since business income insurance replaces lost income, you must submit a business income worksheet listing your business's projected revenues and expenses during a period specified by the insurance company. You must submit this information before the policy is issued or renewed each year.
Value reporting and accounting
Although the savings on premiums for this option are often minimal, value reporting accounting makes sense for companies with inventory levels that vary throughout the year. This means the policy amount and premium adjust according to the fluctuating inventory value.
The insurer typically determines the premium based on this formula:
Value of the business ÷ $100 x Insurer's premium rates
Here are some key points to consider:
- There are typically two premium rate options: monthly and annual.
- Your business, as the policy owner, will be responsible for reporting inventory levels to the insurer during each month's designated time period.
- If the inventory exceeds the reported value level at the most recent period before the time of the loss, you may have a coverage shortfall. If your insurer finds you did not report accurate inventory levels, that could have grave implications for you as the policy owner.
Now that you understand coinsurance with property insurance coverage, work with your company accountant or insurance agent to see what plans and options best fit your small business. Read the details and specifics on your declarations page, and make sure you understand the costs associated with business insurance.