Tuesday Morning Insurance Tidbit - Co-Insurance!!!!!

[InsuranceMan]

The very best of Tuesday mornings to you!!!!!!!

     Yes, Tuesday is upon us once again!  I know we all look forward to what that means!  It is time for today’s installment of the TMIT.

     Today I am going to shed some light on something that I have mentioned many times in the past but never really took the deep dive on.  That “something” is co-insurance.  Ah, co-insurance.  This “something” is something that most insurance agents cannot even wrap their minds around.  Don’t believe me, just ask them.  I have actually had conversations with underwriters who have said that they really don’t quite understand it.  Well, ok.  I guess their job is underwriting and not claims adjusting, BUT STILL!!!!!!!!!!

     As you sit down with your insurance policy to give it a loving perusal (really, who does this?!?!?!!) you will inevitably come across your property section of the policy.  In that section you will see the amounts of coverage you have in regard to your building (if you own it, or maybe your tenant improvements and betterments), your equipment (at least I hope you have coverage for that), your contents or business personal property (BPP), and maybe even your stock on hand (if your agent knows what they are doing that is) to name a few.  If your policy is of a more standard ilk, you will see the description of what is being covered, the limit of value of that coverage, your deductible, and more likely than not, your co-insurance limit.  OOooooooo ……  Yep, there it is!!!!!!  It is the insurance equivalent of spotting a unicorn in an open field.  It is mythical, it is magical, and really, when you see it, you may rub your eyes and wonder silently, “What the heck am I looking at?!?!?!?!?!”

     Co-insurance comes in a myriad of different flavors depending on the carrier providing your coverage, but typically you will see an 80%, 90%, or in some cases 100%.  I will say that one of the only times you see a 100% co-insurance clause should be if it is an “agreed value” or something of the like.  Fear not dear reader, I will explain this so that you understand it, no matter what percentage you have listed.  Then, armed with this all-knowing insurance geek knowledge, you can sit around your next dinner party or tasting and astound people with your incredibly in-depth repertoire of insurance knowledge, which to be honest, probably won’t get you anywhere.  REGARDLESS, let’s get to it.

     For this example we will use your building value (fear not, if you do not own your building you can simply apply this to whatever aspect of property coverage you like, it all functions the same way).  Let us hypothesis that you have your building listed with a nice round value of $1,000,000 (places pinky to corner of mouth with one eyebrow lifted)!!!!!!!  Excellent.  Maybe your agent went to the painstaking lengths to run a Marshall & Swift cost estimator or some equivalent based on contractor costs and types of materials used in your location to accurately decipher what your actual building costs would be if you needed to rebuild from the ground up.  Wait, what?!?!?!!  Who did what now?!?!?!  Well, this is an interesting point of fact.  Where did your insurance amount come from?  Did you give it to the agent and they just said ok and used it?  Is it what the property would sell for if you wanted to sell it????  Either way, dollars to donuts, it is wrong. 

     First of all, your agent should always be providing you with a replacement cost estimation of what it would run if you had to rebuild the entire building, end of story.  If they have not done that, run, screaming!!!!  Not that you don’t know your building and what intrinsic value it may have to you, but in this case, the cost of construction is ever changing and the only accurate way to know what that cost would be is to do an “Insured To Value” (ITV) or “Total Insured Value” (TIV) cost estimation based on the most recent and up to date figures available in your area.  As to “what would it sell for”, again, WRONG!  The sale value takes into account things such as location, overall land and land size, etc.  The sale price is not what it would take to rebuild the building.  In fact, sometimes the sale price could be much more, and in some cases it could be much less that what the building alone would cost to replace.  Interesting, isn’t it?!?!?!?!?!

     In fact, I am going to use a real-life example for you so you can see how dangerous this can be.  I have a client in a middle of the country city, a city that was hit hard with having too much warehouse real estate and not enough buyers for the market.  He was able to score an incredible deal on his building.  He procured a 10,000 square foot warehouse for around $150,000!!!!!!  That comes out to $15 a square foot (not including the land), which is UNHEARD OF!  He calls me all excited and wants to get insurance coverage for his distillery in this location.  I said great, and congratulations.  He tells me that he wants to insure everything like it was before, but now he owns his own building (proud moment for him to be sure) so he wants to include that on the policy for $150,000.  WHOA!!!!!  Pump the breaks … What?  He tells me of the amazing deal he got, and he only wants to insure the building for what he has into it.  Can anyone say, “co-insurance clause”?!?!?!!?

     OK, here we go.  A co-insurance clause is put into insurance policies (almost always reflected as a percentage) and used by insurance companies to ensure that policyholders insure their property (again, any kind of property) to an appropriate value.  Why do they do this?  Well, it is a way for the carriers to make sure that they are receiving a fair and accurate premium for their risk involved in insuring the property.  Ah yes, it all boils down to money!  A prime example is the one that I just gave (as by design).  This insured wanted to insure his building for $150,000 when the true replacement cost of the building would be much higher.  The premium to insure a $150,000 building may be around $1,125 (if it is a $0.75 rate) as opposed to a premium of nearly $7,500 in order to insure a $1,000,000 building value.  Now you can see why the carrier is interested in making sure that things line up correctly.  This is one of the reasons why they have the co-insurance clause.

     Co-insurance works like this:  It is the amount of insurance you DID have at the time of the loss divided by the amount of insurance your SHOULD have had (and just where does that value come from you are wondering????? You guessed it, mainly from an ITV/TIV that the claims adjustor runs, usually from Marshall & Swift.  Oh, all the pieces are fitting together like I had this planned out or something!!!! The voice of experience is loud and clear coming from me!).  Take that percentage, multiply it by the loss amount, subtract your deductible and that is what you get reimbursed from the carrier.  Lost yet?  Most people are, even those who have been in insurance for years.  It is easy to understand when we go back to our example.  We will get there in a minute, I promise.

     If this insured’s building has a true replacement cost of $1,000,000 and he has an 80% co-insurance clause, this means that to be in compliance with this provision he MUST insure his building to at least $800,000 (0.80 x $1,000,000 = 800,000)  If he insures his building to that amount, he can avoid any kind of co-insurance penalty and he would receive the full amount of insurance (minus the deductible) in the case of a loss.  Keep in mind that he will only be able to recoup the amount of value shown on the policy coverage form ($800,000 in this case), which would leave him having to out-of-pocket $200,000 in order to build this same $1,000,000 building, but that is better than what happens if you do incur a co-insurance penalty.  OK, now that you understand that aspect, I will illustrate what happens if you are out of compliance.

     In our example it would look like this:  $150,000 (DID have) / $800,000 (SHOULD have had since the value is $1,000,000 @ 80% = $800,000) = 0.1875 or 18.75%  Yep, if an insurance agent didn’t know any better (which I of course do!!!!!!!) this client would have only had his building insured to 18.75% of its actual replacement value.  VERY BAD!!!!!  Here is the equation:

 

                                                                                    Amount of insurance the insured DID have (if they had not known better):  $150,000

                                                                                    ---------------------------------------------------------------------------------------------------------------------------------------   = 18.75%

                                                                                   Amount of insurance the insured SHOULD have had:                                         $800,000

 

     Obviously the insured is WAY out of compliance here.  What happens next may make you cringe or toss your cookies, so hold on tight or prepare to look away!  You have been warned.  If the building were partially damaged, let’s say to the tune of $50,000 here is how this would play out:

 

                                                                                  $150,000 (DID)

                                                                                ---------------------------  = 18.75% multiplied by the loss amount of $50,000 – Deductible

                                                                               $800,000 (SHOULD)

 

     So you would have a co-insurance equation that looks like this:

             18.75% x $50,000 = $9,375 - $1,000 deductible = $8,375 insurance claim payment.

     GASP!!!!  As you can see, due to the insured being out of compliance and the co-insurance penalty being implemented, this insured is only going to received $8,375 on a $50,000 claim.  This leaves this poor bugger having to out-of-pocket $41,625 in order to repair the building to bring it back up to where it was prior to the loss.  Horrifying, right?!?!?!?!?!

     I don’t want to leave you with that vision today though, so I am going to show you what happens if everything is a hunky-dory!  Same situation, but we have the building insured at $800,000.

                                                                               $800,000 (DID)

                                                                             --------------------------  = 1 or 100% x $50,000 loss - $1,000 deductible = $49,000

                                                                          $800,000 (SHOULD)

     AND THE CROWD GOES WILD!!!!!!!!!!  Here is the real deal folks and what you really need to know about co-insurance.  Just don’t even play the game.  My advice is to never try to get into a situation where you are trying to hit right on the value you need to meet your co-insurance limit.  The price of concrete fluctuates, drywall, plywood, etc.  Even if you think you are right on the money, it could all be different tomorrow and it could cost you big time!  Think of this, what is it going to cost you to insure your building to its full value instead of 80% of its value?  Well, in the case I gave above, it may cost you $1,500 more a year to insure your building (maybe!!!!) at $1,000,000 as opposed to playing the co-insurance game of Roulette and having it at $800,000 only to find out that is not enough.  Do not scrimp on your coverage here, please, I implore you.  Unless you are a “let it all ride on red” kinda gambler, this is something you need to stay away from.

     There are ways to shave some of the costs off your building replacement cost, there are.  I have tricks and tips as to how to get some of the value down, but I am not going to share that here.  Too many non-superhero agents read my posts to try and garner some of my super insurance knowledge, but there are ways to reduce the overall ITV/TIV.  If you are interested in that further or need a comprehensive review of all things insurance-y, get a hold of me, InsuranceMan 2.0!!! and I would be glad to lend you a helping superhero hand.  Until next time dear reader …

 

Stay Vigilant,

Aaron Linden

a.k.a. InsuranceMan 2.0!!!

307-752-5961

insruanceman2.0@yahoo.com