Coinsurance - What Insureds Need to Know


Coinsurance (continued from previous page) purposes. Replacement cost and actual cash value can mean one thing to the insurance buyer, and something else to the broker or adjuster. Insureds who normally purchase used equipment, for example, might assume that they can replace a lost piece with another used item. In fact, replacing the piece could mean not only incurring the cost of a new unit, but paying to have it delivered and installed. Sometimes installation costs can be as high as the price of the machine itself, yet they are often left out when determining insur- ance values! So, it’s essential that all of these factors and interpretations be thought through.

Many insureds rely solely on his- torical or accounting records, and value inventories differently for different purposes. For instance, inventory value purposes and the insured might submit this same inventory or a depreciation schedule for setting insurance values. Unless the risk is a new business, some pieces of equipment might not be listed. That equipment could be very valuable to the business, but for tax reasons it is no longer listed on the schedules sup- plied to the insurance carrier. If a loss occurs, the insured is likely to suffer a coinsurance penalty because the inven- tory at risk is of greater value than that insured.

As we saw in the case of company XYZ, this can dramatically undervalue an inventory in which parts and supplies have been expensed rather than capital- ized, because much of its equipment will not appear on the asset list. Tools, for example, if expensed to a specific project, must be replaced in the event of a loss, yet their value would not have been included in the insured values.

These valuation problems are all too common. But even more surprising is the fact that in many instances, the insured has absolutely no idea that the submitted valuations are incorrect. With better communication and education, most of these valuation errors can be avoided!


Insureds frequently make a mis- take here when answering the question, “How much would it cost to replace your building?” They don’t realize that what replacement means to them can be very different from what it means to claims personnel settling a loss.

When valuing a building for its replacement cost, pay close attention to the details of the structure and the materials used in its construction. If the original values were determined through a simple square footage calculation, or a cursory examination of construction materials, significant discrepancies can result when the insurance company’s representatives establish values after a loss. Such discrepancies can translate into a coinsurance penalty.


A very important element in estab- lishing proper valuation for business interruption coverage is the company’s growth factor—in terms of sales or sales value of production. Most insureds tend to think of only projected profit and not of the full impact of additional sales, production, or the accompanying payroll, cost of raw materials, etc.

The completion of the business interruption worksheet provides the perfect opportunity for the broker and client to review not only the company’s past performance, but also its future potential. “What if” scenarios can be developed to provide valuation data that can forecast potential recoveries in the event of a loss.

Terminologies used in the policy carry different meanings than used by the accounting profession. It is necessary, therefore, to unravel these differences prior to making a determination of sums to be insured.

Further, it is important to determine the time period that will be used for establishing value at the time of loss. Historically, valuation was based on the 12-month period following the date of loss; however, more recent policy forms require the valuation to be based on the 12-month period following the policy’s inception date or most recent anniversary date.


When values are determined, coinsurance and its requirements should be viewed from a claims perspective to support better communication. Ask questions like: What would happen in the event of a loss? If the insured lost a plant or a section of a plant, how would the company adjusters approach valuation of the property to determine recovery? What would the actual replacement cost of the structure, and equipment and all of the inventory be? What would the actual cash value of that same property be, and how would that compare with the stated values? Has this information been reported correctly? And have we estimated what the true business inter- ruption value would be, considering growth, and what it would be in the eyes of an adjuster?

The time to eliminate a potential coinsurance penalty is before the loss occurs. That means both the broker and client must communicate effectively up front, and understand the language that’s being spoken. There’s no better way to ensure that reported values will be in line with the values used at the time of any subsequent adjustments. When a broker has cultivated that understanding, he or she has acted in the very best interests of the client.