﻿Forensic Insight: What is Co-Insurance

# Forensic Insight: What is Co-Insurance?

Handling hundreds of commercial property insurance claims every year, we have found that few things cause people more confusion than the concept of co-insurance. This article provides a brief overview of what co-insurance is, why it exists, and how it is calculated.

## What is Co-Insurance?

In simplest terms, co-insurance requires that policyholders insure their businesses for an amount equal to at least the value of the covered property or earnings stream, multiplied by the co-insurance percentage.

If the policyholder is looking to save premium dollars by insuring less than the required amount, then they become a “co-insurer” for any loss, and will only recover from the insurer a portion of any loss they suffer, even if the total amount of the loss is less than the policy limit.

## Co-Insurance Calculation – A Simple Example

For example, a building valued at \$1,000,000 with a co-insurance requirement of 90% must be insured for no less than \$900,000.

If the policyholder decides to purchase insurance for less than \$900,000, they are agreeing to retain part of the risk rather than transfer it to the insurance company. Therefore the policyholder becomes a co-insurer and will “share” the loss with the insurance company.

#### = Collectible Loss

Using the example above, assume the policyholder only purchased \$600,000 of insurance, and suffered damage to the building valued at \$300,000. In that case, the insurer will pay the insured the following:

(\$600,000 / \$900,000) x \$300,000 = \$200,000

Even though the value of the damage was \$300,000, since the policyholder only insured 2/3rds of the required value (i.e. \$600,000 out of the required \$900,000), the insurance company will only pay for 2/3rds of the damage.

## Co-Insurance for Business Interruption Losses

Co-insurance also commonly applies to business interruption (“BI”) coverage. In order to recover 100% of any BI loss (up to the policy limit), the insured must have coverage in place equal to its annual BI value (equal to projected revenue multiplied by the gross earnings/profits/business income rate, as defined by the policy).

It can be difficult for policyholders to know how to project how much insurance they will need. This requires both:

• Projecting revenue for up to two years in advance (since a loss suffered towards the end of the policy period will require a co-insurance calculation based on projected revenue over the upcoming year); and,
• Understanding what BI rate to apply to the revenue forecast.

Some general issues to consider in setting business interruption limits so as to avoid co-insurance issues include:

### Revenue Projections

• Is the business in a mature industry or a new start-up?
• What is the overall industry trend?
• Are there any regulatory changes impacting the business?