Coinsurance Formula for Home Insurance: Definition, Examples

What Is the Coinsurance Formula?

The coinsurance formula is the homeowners insurance formula that determines the amount of reimbursement that a homeowner will receive from a claim. The coinsurance formula becomes effective when a homeowner fails to maintain coverage of at least 80% of the home's replacement value. Those who file a claim in this situation will only receive partial reimbursement according to the formula.

How the Coinsurance Formula Works

Coinsurance is a clause used in insurance contracts on property insurance policies such as homeowners insurance. The clause ensures policyholders insure their property to an appropriate value and that the insurer receives a fair premium for the risk. If you have an outstanding mortgage loan on the property, your mortgage lender will likely require you to have a minimum amount of coverage.

Coinsurance is usually expressed as a percentage. Most coinsurance clauses require policyholders to insure 80%, 90%, or 100% of a property's actual value. For instance, a building valued at $1,000,000 replacement value with a coinsurance clause of 90% must be insured for no less than $900,000. The same building with an 80% coinsurance clause must be insured for no less than $800,000.

The coinsurance formula is relatively straightforward. Begin by dividing the actual amount of coverage on the house by the amount that should have been carried (80% of the replacement value). Then, multiply the result by the amount of the loss, which will give you the reimbursement amount.

Examples of the Coinsurance Formula

Here are two examples that demonstrate how the coinsurance clause works.

Example 1: Inadequate Amount of Coverage

Building Value: $1,000,000
Coinsurance Requirement: 80%
Required Amount of Insurance: $800,000
Actual Amount of Insurance: $600,000
Amount of Loss or Cost of Repairs: $300,000

The coinsurance formula is:

[(Actual amount of insurance / Required amount of insurance) X amount of loss] - deductible = Amount of claim paid by the insurer

Based on the amounts above, the formula produces the following:

• ($600,000 actual coverage / $800,000 required coverage) = 0.75 or 75% of the required minimum coverage
• 0.75 X $300,000 in damages = $225,000 paid by the insurer for the claim

The insurance company will pay $225,000 of the claim despite $300,000 worth of damage. The owner absorbs a $75,000 coinsurance penalty since they did not buy enough coverage. Therefore, the owner pays out of pocket for 25% of the loss. 

Even though the owner had more than enough coverage to cover the claim amount—$600,000 in coverage for a $300,000 claim—the owner was underinsured. The owner had only 75% of the required minimum coverage of $800,000. As a result, the insurer only paid 75% of the claim amount.

Example 2: Adequate Amount of Coverage

If the building had been insured to the amount required by the coinsurance clause (in this case, 80%), the coinsurance calculation would look like this:

Building Value: $1,000,000
Coinsurance Requirement: 80%
Required Amount of Insurance: $800,000
Actual Amount of Insurance: $800,000
Amount of Loss or Cost of Repairs: $300,000

Here's the formula again:

[(Actual amount of insurance / Required amount of insurance) X amount of loss] - deductible = Amount of claim paid by the insurer

And here's the calculation:

• ($800,000 actual coverage / $800,000 required coverage) = 1; required coverage satisfied
• 1 X $300,000 in losses = $300,000 paid by the insurer
  

In the second example, the owner met the coinsurance requirement and did not need to pay anything out of pocket. In other words, the insurer will pay the total amount of the $300,000 claim without penalty to the owner.

Monitor Your Coverage

These examples illustrate why it's important to maintain enough insurance coverage to match the percentage of the property value required by the insurer. If the property value increased by 20% to $1,250,000, the 800,000 in coverage would no longer be adequate because it would represent 64% of the property value ($800,000 / $1,250,000) and not 80% required by the insurer.

It's also important to know how much of a deductible you are responsible for in your policy. The examples above assumed no deductible. If there was a deductible, the deductible amount would reduce the insurance company's claim payment, and the owner would be responsible for paying that amount out of pocket. Coinsurance clauses are also found in business interruption policies. These clauses ensure that policyholders insure their revenue stream to an appropriate value.

Frequently Asked Questions (FAQs)

The Bottom Line

The coinsurance formula determines the amount of reimbursement that a homeowner or property owner will receive from a claim. Homeowners are required to have a minimum amount of coverage when they buy a homeowners insurance policy, which is typically 80% of the property's replacement value. The coinsurance formula is applied when a property owner fails to maintain the minimum coverage. As a result, the owner will be responsible for a percentage of the loss out of pocket.