March 30th, 2020
The agreed amount endorsement form, often known as the agreed value clause, is an endorsement added to a property policy when the insured and the insurer agree on the insurable value of a specific property. The insurance company then waives all coinsurance penalties and agrees to pay up to the full limit should a total loss happen.
Not all insurance carriers will offer the agreed amount value clause. Doing so puts the insurance company at risk for customers underinsuring their buildings and the insurance company having no recourse.
We can agree that the agreed amount endorsement is good because it waives the coinsurance penalty, but what is the coinsurance penalty?
The coinsurance penalty is part of most commercial property insurance policies. It states that if you misrepresent your building's value to the insurance company, they are not obligated to pay the full claim.
One might wonder why this endorsement is necessary; after all, if the insured chooses a lower building limit, they will receive a lower payment in case of a total loss.
In that instance, you are right. The problem is that the vast majority of claims are not total losses – they are claims for partial damage.
The typical claims that you hear about (wind damage, fire damage, theft, vandalism, and so on.) don't usually destroy your building; they cause damage to a specific section or part.
So, what is keeping an insurance buyer from buying an insurance policy for $250,000 on their $400,000 building? The bigger building will, of course, have more losses, and the size of those losses will be bigger (larger roof, more material). The insured can pay nearly half the premium they should and still get the same claims paid.
On a large scale, this would cause a near doubling of insurance rates to pay for these claims, destroying the reason why it is done in the first place.
Additionally, instead of misrepresenting your building values, the correct way to achieve this result is to report the $400,000 in property and add a $250,000 loss limit. This limits the maximum payable to $250,000 while still getting partial claims paid for. You will also save premium dollars and have more predictable claim outcomes this way.
The misrepresentation of building values is the reason coinsurance was created. Coinsurance places automatic penalties if an insured misrepresents the value of their building.
With that said, if you are properly insured, the penalty will have no effect on your claim payment.
The insurance industry uses a universal formula to penalize the underinsurance of buildings. In almost all cases, you can use the following formulas to determine how a underinsured claim on your building would be handled.
How To Determine The Coinsurance Penalty:
Insurance purchased by customer / Insurance customer should have purchased = Coinsurance penalty
You then multiply the penalty by the total claim amount to determine how much the insurance company will pay.
How To Calculate The Total Amount Owed By Insurance Company For A Claim:
Coinsurance penalty x total property damage = Total money owed by insurance company
Let’s say you purchased a building that was 10,000 square feet and the true replacement cost (total dollars required to build a new building or similar size and construction) was $1,000,000.
In order to make the insurance cheaper, you argued that the building could be built brand-new for $750,000. You ask your insurance broker to reduce the building’s value and reduce your premium by 25%.
During a terrible storm, your roof is severely damaged and needs a complete replacement. You receive a quote from a contractor for $40,000, but the insurance company sends an appraiser out and determines the replacement cost of your property is $1,000,000.
The insurance company would take the amount of insurance you purchased and divide it by the amount that you should have purchased.
$750,000 / $1,000,000 = 75%
Now take the 75% coinsurance penalty and multiply it by the total damage.
75% x $40,000 = $30,000
The most the insurance company will pay for that roof is $30,000, leaving $10,000 as an out-of-pocket expense for your business (not counting any deductibles). This assumes the coinsurance penalty is 100%.
In another scenario, if you and the insurance company agreed on the value of the property and they waived the coinsurance penalty, they would be responsible for all $40,000 (assuming no deductible).
Some of the benefits include:
Fewer claims adjusters.
More predictable outcomes.
It is a smoother and faster claims process that allows you to better plan for catastrophic events.
If you want a detailed breakdown of how your specific insurance carrier will calculate a coinsurance policy, let us know! We’d be happy to chat with you.
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