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:
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.