Coinsurance

An Important Condition of Commercial Property Insurance Policies

Coinsurance is often misunderstood in first party property insurance. It is a clause that causes frequent dissatisfaction with insureds over claim settlements.

Historically most losses are partial losses. It is rare that the entire building or amount of covered property is destroyed. Knowing this, individuals deciding to insure their business property might insure for only part of its value. The insured may reason that since it is more likely to have a partial loss than a total loss, it is wasteful to spend premiums on complete insurance.

This reasoning, of course, defeats the concept that insurance is the sharing of risk. If the insured does not obtain insurance for the total values at risk, then the risk is not shared equally with other insureds. If most insureds chose to insure only part of the value of their property, the insurance industry would still have approximately the same number of claims to pay; however, the premiums that it collected to pay those claims would be vastly reduced. In order to have enough money to pay the losses, insurers would charge more for the lower values that insureds chose to insure. Those insureds who chose to insure the full value of their property would pay even more than they now pay for the same amount of coverage. Encouraging insureds to carry full insurance on their property allows premium levels to be fairer and that is why the coinsurance provisions were created.

The authors of the coverage forms were aware that expecting insured individuals and businesses to carry coverage for 100 percent of the value of their property was unrealistic. They allowed the choice (and the corresponding premium level) of insuring against the risk of loss of only a percentage of the value of the property.

The percentage that the insured chooses is called the “coinsurance percentage.” The insured and the insurance company are coinsuring the property because the percentage that the insured chooses not to insure represents the amount of coverage that the insured will pay.

In order to encourage insureds to insure a reasonably high percentage of their property’s value, the coverage form provides the incentive of coverage extensions—broader coverage—to those insureds who choose at least an 80 percent coinsurance.

The term “coinsurance” means “a relative division of the risk between the insurer and the insured”. 15 Couch § 220.3. Coinsurance clauses are provisions in insurance policies that require the insured to maintain coverage to a specified value of the property. If the insured failed to maintain sufficient limits he or she becomes a coinsurer and must bear his or her proportional part of the loss.

In regard to coinsurance, the Michigan Court of Appeal concluded that there is no ambiguity in the coinsurance provision. Neither the policy application nor the declarations page of the policy addresses the operation of coinsurance, except to indicate a percentage that would be integrated in the coinsurance clause. [Royal Property Group, LLC v. Prime Insurance Syndicate, Inc., 706 N.W.2d 426, 267 Mich. App. 708 (Mich. 2005)]

The Sixth Circuit, following Royal Property Group, supra dismissed plaintiff’s claim that there is something vicious about co-insurance. Its legality is no longer a debatable question. It has been authorized by law for over 40 years. [Masonic Temple Ass’n of Grand Rapids v. Michigan, 323 Mich. 662, 36 N.W.2d 317, 320 (1949) (citing Fine Arts Corp. v. Kuchins Furniture Mfg. Co., 269 Mich. 277, 257 N.W. 822 (1934)); at Melson v. Prime Ins. Syndicate, Inc., 429 F.3d 633 (6th Cir. 2005)]