THE "CO-INSURANCE" PENALTY - OR INSUFFICIENT INSURANCE TO VALUE - AND ITS IMPACT ON AN INSURED
What happens when an insured does not carry enough insurance on his/her/its property? Often, the answer is that, that insured, when suffering a loss, also suffers what some have characterized as a “co-insurance” penalty, or as some prefer, a penalty for maintaining insufficient “insurance to value.”
Remember that, for the most part, the insured is the person initially setting the value of the property. In most instances, an insured will be asked what the property is worth by the agent, or perhaps how much insurance is designed. When that coverage is written, and a loss occurs, the companies will often look to see if the insured had sufficient insurance when compared to the value of the property.
Many policies - especially commercial policies - contain a formula for determining the amount of coverage owed in instances where there is insufficient insurance to value. Here is a typical formula:
1. Coinsurance
If a Coinsurance percentage is shown in the Declarations, the following condition applies.
a. We will not pay the full amount of any loss if the value of Covered property at the time of loss times the Coinsurance percentage shown for it in the Declarations is greater than the Limit of Insurance for the property.
Instead, we will determine the most we will pay using the following steps:
(1) Multiply the value of Covered Property at the time of loss by the Coinsurance percentage;
(2) Divide the Limit of Insurance of the property by the figure determined in Step (1);
(3) Multiply the total amount of loss, before the application of any deductible, by the figure determined in Step (2); and
(4) Subtract the deductible from the figure determined in Step (3).
We will pay the amount determined in Step (4) or the limit of insurance, whichever is less. For the remainder, you will either have to rely on other insurance or absorb the loss yourself.
So, let’s go through an example. Assume that an insured has a limit of coverage for $100,000.00. When a loss occurs, the value of the property at the time of loss is placed at $250,000.00. The policy has an 80% coinsurance percentage, meaning that the building has to be insured to 80% of value. The deductible is $500.00, and the amount of loss is $50,000.00. Let’s follow the steps set forth above:
(1) We first multiply the value of property at the time of loss ($250,000) by the coinsurance percentage (80%). This product is $200,000, which represents the minimum amount of insurance an insured must have to be in compliance with the Coinsurance requirements.
(2) Since the insured does not have that much coverage, we proceed through the calculation. We divide the limit of insurance ($100,000.00) by the figure derived in step 1 ($200,000). This leads to a figure of .50
(3) Then, we would multiply the total amount of loss ($50,000.00) by the figure in step 2 (.50), which gives us $25,000.00
(4) Then we subtract the deductible from this figure ($25,000.00 - $500.00), leaving $24,500.00.
The company’s proper obligation on a $50,000.00 loss is thus only $24,500.00.
Whose fault is under-valuation? In most cases I have seen, the fault lies with the insured. Remember that, typically speaking, an agent has no duty to verify the accuracy of information provided by an applicant when seeking coverage. Thus, when an applicant walks into an insurance agent’s office, and asks for $300,000.00 in insurance on his home, that’s what the agent will write. Clearly, there are some circumstances where the agent’s expertise is involved, and even circumstances when an agent provides the value, but the typical scenario involves the applicant/insured seeking a specified coverage amount. Also, remember that the carrier is actually not under a duty to inspect the property once the application is submitted and the policy is written. Elsewhere in this blog, we have discussed the imposition of the valued policy law, which can arise when the carrier has failed to inspect the property. But, the carrier can simply decide not to conduct the inspection and live with the valued policy law in cases of covered total losses. Therefore, the responsibility for valuation really lies with the insured, at least initially.
Rules of Interpretation for Insurance Policies
Insurance litigation requires a lot of briefing so we keep a stash of helpful citations that are often used in our court filings. An example is the rules that courts must follow when interpreting insurance policies. These rules of construction can be quite helpful in the right case. Below are several that insurance practitioners should not forget:
- Insurance contracts, being subject to the same rules of construction as contracts generally, should be interpreted and enforced as written. Absent fraud or mistake, the terms of a contract should be given their plain and ordinary meaning, for the primary rule of contract interpretation is to ascertain and give effect to the intent of the parties. U.S. Bank, N.A. v. Tennessee Farmers Mut. Ins. Co., 277 S.W.3d 381, 387 (Tenn. 2009).
- The parties' respective rights and obligations are governed by their contract of insurance whose terms are embodied in the policy. As with any other contract, our responsibility is to give effect to the expressed intention of the parties, by construing the policy fairly and reasonably, and by giving the policy's language its common and ordinary meaning. We are not at liberty to rewrite an insurance policy simply because we do not favor its terms or because its provisions produce harsh results. In the absence of fraud, overreaching, or unconscionability, the courts must give effect to an insurance policy if its language is clear and its intent certain. Angus v. Western Heritage Ins. Co., 48 S.W.3d 728, 731 (Tenn.Ct.App. 2000).
- Exclusionary clauses are to be strictly construed against the insurer when drafted by the insurer. Palmer v. State Farm Mut. Auto. Ins. Co., 614 S.W.2d 788, 789 (Tenn. 1981).
- The language of the policy must be taken and understood in its plain, ordinary and popular sense. Where language is susceptible to more than one reasonable interpretation, the language is ambiguous. If such ambiguous language limits the coverage of the insurance policy, that language must be construed in favor of the insured. In determining the “plain, ordinary and popular” meaning of language, courts may refer to dictionary definitions. CBL & Associates Management, Inc. v. Lumbermens Mut. Cas. Co., 2006 WL 2087625, 6 (E.D.Tenn. 2006); Am. Justice Ins. Reciprocal v. Hutchison, 15 S.W.3d 811, 814 (Tenn. 2000).
- Language in a policy is ambiguous if it is capable of more than one reasonable interpretation. Tata v. Nichols, 848 S.W.2d 649, 650 (Tenn. 1993). A contract is ambiguous only if it is of uncertain meaning and may fairly be understood in more ways than one. Rogers v. First Tennessee Bank Nat. Ass'n., 738 S.W.2d 635 (Tenn.Ct.App. 1987).
- If possible, all provisions in the contract should be construed in harmony with each other to promote consistency and to avoid repugnancy between the various provisions. Guiliano v. Cleo, Inc., 995 S.W.2d 88, 95 (Tenn. 1999).
- In Tennessee, exceptions, exclusions, and limitations in insurance policies must be construed against the insurance company and in favor of the insured. Allstate Ins. Co. v. Watts, 811 S.W.2d 883, 886 (Tenn. 1991). The entire policy, however, including insuring clauses and exceptions thereto, must be read as a whole. Am. Sav. & Loan Ass'n v. Lawyers Title Ins. Corp., 793 F.2d 780, 782 (6th Cir. 1986). Further, exceptions should not be construed so narrowly as to defeat their evident purpose. Standard Fire Ins. Co. v. Chester-O'Donley & Assocs., Inc., 972 S.W.2d 1, 8 (Tenn. Ct. App. 1998).
- “[T]he paramount rule of construction in insurance law is to ascertain the intent of the parties.” Blue Diamond Coal v. Holland-America Ins. Co., 671 S.W.2d 829, 833 (Tenn.1984).
- The insuring agreement defines the outer limits of an insurance company's contractual liability. The courts are not at liberty to rewrite an insurance policy solely because they do not favor its terms, and must avoid forced constructions that render a provision ineffective or extend a provision beyond its intended scope. As long as a policy's terms are unambiguous, it will be enforced as written, and courts cannot rewrite an unambiguous policy simply to avoid harsh results. Therefore, the insured cannot simply focus on the declarations/summary portion of a contract in isolation; the policy must be read as a whole. Hoyt v. Pyles, 2007 WL 1217264, 5-6 (Tenn.Ct.App. 2007).
- The insuring agreement sets the outer limits of an insurer's contractual liability. If coverage cannot be found in the insuring agreement, it will not be found elsewhere in the policy. Exclusions help define and shape the scope of coverage, but they must be read in terms of the insuring agreement to which they apply. Exclusions can only decrease coverage; they cannot increase it. Exclusions should also be read seriatim. Each exclusion reduces coverage and operates independently with reference to the insuring agreement. Exclusions should not be construed broadly in favor of the insurer, nor should they be construed so narrowly as to defeat their intended purpose. Once an insurer has established that an exclusion applies, the burden shifts to the insured to demonstrate that its claim fits within an exception to the exclusion. Standard Fire Ins. Co. v. Chester O'Donley & Associates, Inc., 972 S.W.2d 1, 8 (Tenn. Ct. App. 1998).
- An insurance contract should be construed in “a reasonable and logical manner.” Standard Fire Ins. Co. v. Chester O'Donley & Associates, Inc., 972 S.W.2d 1, 7 (Tenn. Ct. App. 1998). When coverage questions arise, the components of a policy should be construed in the following order: 1) the declarations; 2) the insuring agreements and definitions; 3) the exclusions; 4) the conditions; and 5) the endorsements. Id.
