Being in the insurance industry, I have met many home and business owners who were very under insured. One medium to large loss on their current policy could cause extreme financial hardship.
Before reading, understand that insurance is different between states. Exact wording and grammar may vary from state to state. The purpose of this post is to explain the concept of coinsurance and persuade you to double check your current policies, to make sure you’re not under insured.
What is Coinsurance?
Coinsurance is a risk sharing strategy between you and your insurance company. Coinsurance helps reduce the frequency of claims for the insurance company. The theory is that by the insured having to share the risk with the insurer, the insured will not abuse the coverage.
In the U.S. insurance market, coinsurance is most common in your health and property insurance policies.
How Does Health Coinsurance Work?
Most health insurance policies contain an 80/20 coinsurance clause. This clause stipulates that the insurer will pay 80% of the expenses above the deductible, while you pay 20% up to a certain limit. Your limit is known as the stop loss or maximum out-of-pocket.
Once the stop loss limit is reached, your insurer pays 100%.
It’s easiest to look at an example – you break your leg while playing football. Your total bills for the injury are $10,000. Your current health policy has a $500 deductible, an 80/20 coinsurance clause, and a stop loss limit of $2,000.
How much will you pay and how much will the insurance company pay?
Coinsurance Formula for Health Insurance
|Coinsurance to stop loss limit ($9,500 X %20)||$1,900||$100|
|Remainder above stop loss limit||$7,500|
Coinsurance on Property Insurance
Coinsurance works differently in property insurance compared to health. However, the concept of risk sharing is the same.
Your insurance policy on your home, when purchased, should equal the replacement cost of your home. The insurance to cover replacement cost is required by the bank. You must carry at least 80% of the replacement cost at the time of loss.
The confusing part about home coinsurance is replacement cost is difficult to predict. In the case of a total loss, you don’t have to rebuild the land, just the house. Therefore, you need to be covered for the current cost of building materials and labor, not how much the house is worth on the market.
The concept of replacement cost is cause for many people being under insured. Most don’t maintain their policy to an accurate replacement cost. If the price of building materials and labor rises, so should the amount you carry on your homeowners policy.
Below is an example of how property coinsurance works:
Your current house has a replacement cost of $200,000. Five years ago you purchased $140,000 of insurance with a coinsurance requirement of 80% and a $1,000 deductible. A tornado goes through your home causing $100,000 in damage. How much will your insurance company pay?
Coinsurance Formula = (insurance purchased/coinsurance) x loss
Amount covered = (($140,000/(80% x $200,000)) x $100,000
Amount Covered = $87,500
- Note: If you would have adjusted your insurance coverage to $160,000, 100% of the loss would have been covered.
Maintain and understand your insurance policies.
For health insurance, the higher your stop loss limit and deductible are, the higher your emergency fund.
For property insurance, ask your insurance agent each year to perform a replacement cost estimator.