The coinsurance formula: how the coinsurance penalty is calculated

What the coinsurance clause says

Many commercial property policies contain a coinsurance clause. The owner agrees to insure the building for at least a set share of its value, typically 80%, 90% or 100%. Most losses are partial, so without the clause an owner could insure a $600,000 building for $100,000, pay a small premium, and still be paid in full for every fire smaller than $100,000. The clause keeps premiums fair: whoever underinsures shares every loss with the insurer, in proportion to the shortfall. That is where the name comes from, the owner becomes a co-insurer.

The formula step by step

1. Should = replacement value at the time of loss × coinsurance %. Bakery: 600,000 × 80% = $480,000.
2. Did ÷ should = insurance carried ÷ should, capped at 100%. Bakery: 360,000 ÷ 480,000 = 75%.
3. Payment = ratio × loss − deductible: 75% × 80,000 − 2,500 = $57,500.
4. Caps: the payment can never exceed the limit of insurance (the amount carried) and never be negative.

In one Excel cell: =MAX(0,MIN(B4,MIN(1,B4/(B2*B3))*B5-B6)). Exam questions and most policy forms subtract the deductible after applying the ratio, as here. Some policies word it differently, so check the actual form.

Worked example: four property claims under a coinsurance clause

Each column is one fictional property claim. Rows 7 to 12 apply the coinsurance formula with the limit cap. Rows 15 to 19 show the different meaning of coinsurance in a health plan.

Worked example: four property claims under a coinsurance clause

	A	B	C	D	E
1	Property claim	Bakery	Office	Warehouse	Shop
2	Replacement value at time of loss	600,000	800,000	1,000,000	250,000
3	Coinsurance requirement	80%	90%	80%	100%
4	Insurance carried (did)	360,000	750,000	700,000	200,000
5	Loss	80,000	120,000	900,000	3,000
6	Deductible	2,500	2,500	5,000	1,000
7	Required insurance (should)	480,000	720,000	800,000	250,000
8	Did ÷ should, capped at 100%	75.0%	100.0%	87.5%	80.0%
9	Formula result: ratio × loss − deductible	57,500	117,500	782,500	1,400
10	Insurer pays (capped at the limit, never below 0)	57,500	117,500	700,000	1,400
11	Owner pays (loss − payment)	22,500	2,500	200,000	1,600
12	Coinsurance penalty (vs. ratio of 100%)	20,000	0	0	600
13
14	Health plan coinsurance (different meaning)	Amount
15	Allowed amount of the bill	2,000
16	Deductible not yet met	500
17	Coinsurance (patient share after the deductible)	20%
18	Patient pays	800
19	Plan pays	1,200

Fictional properties and amounts, exam-style simplification. Real policies differ (deductible wording, agreed value, sublimits). Not insurance or legal advice, check the policy form and your state's rules.

When the owner carries enough

The office in the example is worth $800,000 with a 90% clause, so it should carry $720,000. It carries $750,000, more than required, and the ratio is capped at 100%. On a $120,000 loss the insurer pays the loss minus the deductible, $117,500. Carrying more than required does not raise the payment above the loss. The ratio only ever penalises underinsurance.

Total losses and the policy limit

The warehouse is worth $1,000,000 with an 80% clause and insured for $700,000, so the ratio is 87.5%. On a $900,000 loss the formula gives 87.5% × 900,000 − 5,000 = $782,500, but the insurer never pays more than the limit, so it pays $700,000. The owner keeps $200,000 of the loss. Here the coinsurance penalty is $0: even with a ratio of 100%, the payment would have been capped at the same $700,000. On large losses the limit binds, on small and medium losses the coinsurance ratio does.

The penalty applies to small losses too

A common belief is that underinsurance only matters in a total loss. The shop shows the opposite. It must carry 100% of $250,000 but carries $200,000, a ratio of 80%. On a $3,000 claim the insurer pays 80% × 3,000 − 1,000 = $1,400 instead of $2,000, a penalty of $600 on a claim far below the limit.

Compliance is measured on the value at the time of loss, not when the policy was bought. Rising construction costs can push a building below its requirement without anyone noticing. Owners avoid this with regular valuations, an agreed value endorsement that suspends the clause, or an inflation guard that raises the limit automatically.

Coinsurance in health insurance means something else

In a health plan, coinsurance is the percentage of the allowed amount the patient pays after the deductible, until the out-of-pocket maximum is reached. With a $2,000 allowed amount, $500 of deductible still to meet and 20% coinsurance, the patient pays 500 + 20% × 1,500 = $800 and the plan pays $1,200 (rows 15 to 19). There is no "did ÷ should" ratio and no penalty. Exams for property and casualty licenses test the first meaning, life and health exams the second.

Common mistakes

• Applying the coinsurance % to the insurance carried. Should = replacement value × coinsurance %, never the limit × coinsurance %.
• Taking the deductible off before the ratio. The usual exam formula is ratio × loss − deductible. Ratio × (loss − deductible) gives a different, higher payment.
• Forgetting the limit. The formula can produce more than the amount insured on a large loss. The payment is capped at the limit.
• Letting the ratio exceed 100%. Overinsurance never pays more than the loss minus the deductible. Cap did ÷ should at 1.
• Using the value at policy inception. Compliance is tested on the value at the time of loss, which may have risen since.
• Mixing up property and health coinsurance. One is a penalty ratio for underinsurance, the other a cost-sharing percentage after the deductible.