A building has a replacement cost of $500,000. The policy carries an 80% coinsurance clause, the insured carries only $300,000 of coverage, and a covered loss of $100,000 occurs with a $1,000 deductible. Using the standard coinsurance formula (Did/Should) x Loss - Deductible, how much will the insurer pay?
Explanation
Should carry = 80% × $500,000 = $400,000. Did carry = $300,000. Ratio = 300,000 ÷ 400,000 = 0.75. Recovery before the deductible = 0.75 × $100,000 = $75,000. Subtract the $1,000 deductible and the insurer pays $74,000. The lesson is that insuring below the coinsurance requirement carries a real penalty: the insured does not recover the full $100,000 even though the policy limit is far above the loss.
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