A commercial building is insured under a policy with an 80% coinsurance clause. The building's replacement cost is $500,000, but it is insured for only $300,000. After a $100,000 covered loss, how much will the insurer pay before any deductible?
Explanation
The coinsurance formula is: (amount carried / amount required) x loss = payment. The amount required is 80% of $500,000 = $400,000. The amount carried is $300,000. So $300,000 / $400,000 = 0.75, and 0.75 x $100,000 = $75,000. Because the insured carried only 75% of the required amount, the insurer pays 75% of the loss and the insured absorbs the rest as a penalty for underinsurance.
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