In Property & Casualty Insurance Procurement & Litigation (Ten Recurring Themes Every Lawyer Should Know) insurance expert witness David L. Stegall, CPCU, ARM, ARe, RPA, of Risk Consulting & Expert Services writes on ten recurring themes that often lead to litigation. Attorneys either dealing in insurance procurement litigation issues or with clients who purchase insurance may want to consider these ten themes:
Theme 9 of 10 Coinsurance is one of the most common insurance purchase misunderstandings. The coinsurance clause/penalty is a stated understanding and agreement within most property policies that requires the property owner to purchase insurance for a certain percentage of the full value of the property. The trade-off is, if the property is insured to the required value, the insurance company will use the lowest possible rates for calculating premiums. However, if the property is not insured to the required amount, then partial claims (versus total losses) will be paid in a ratio of the amount insured divided by the amount that should have been insured multiplied by the partial loss. The Co-Insurance Penalty formula is: the amount insured, divided by the amount required to be insured, multiplied by the partial loss amount, equals the claim payment amount.
Example: Property is purchased for $120,000 (includes the land, which is not insured). The building on the property is 25 years old and has a replacement cost value of $100,000. There is a mortgage on the property for $50,000, and the mortgage company requires fire insurance coverage of at least that same amount. The owner buys a fire insurance policy with a limit of $50,000 and the policy has an 80% coinsurance clause. During the policy period, a fire occurs causing $20,000 in fire damage. How much will the insurance company pay? Answer: $12,500 (not $20,000.) Why? Amount insured ($50,000) divided by the minimum amount for which it should have been insured for ($80,000, which is 80% of $100,000) multiplied by the amount of the partial fire loss ($20,000) equals $12,500. This is a relatively easy calculation but a concept that is almost never understood by a claimant at the time of a loss.