How does underinsurance penalty come to play, and why does it matter? Shouldn’t consumers be able to choose the amount of coverage they desire? If they only want 50K worth of coverage for inventory, or 100K for loss of income, who’s to say no?

Fact of the matter is understanding underinsurance penalty or “coinsurance” is crucial because it may negatively affect your claim settlement. Most business policies have a coinsurance requirement, typically anywhere from 80% to 100%. The purpose of applying a coinsurance is to encourage consumers to purchase insurance to value. And this translates to adequate premium for the insurance company. It would make rates equitable and better position the insurance company to withstand the wild rollercoaster ride in the market place. If the insurance company doesn't collect adequate premium or set rates that properly reflect the risk, chances are it will bump up the rates significantly going forward making a lot of customers unhappy. 

Here's an example of how coinsurance works and why they're important.

Let’s say you have a policy with an 80% coinsurance.

You have 50K coverage on your property. But the actual value of goods is 150K.

Using 80% coinsurance, your coverage limit should be at least 120K (150K x 80%).

A fire broke out in your office and damaged 30K worth of goods. And you may think since I have 50K coverage, I should be all good. We’ll see about that.

·         50,000(did) / 120,000(should) = 0.416

·         0.416 x 30,000 (loss) = 12,500 (amount of settlement before deductible)

You were thinking that you would receive 30K for damaged goods, but you’ll only get 12,500. That’s a 17,500 penalty! 

The point is, if you have a coinsurance policy make sure to do your due diligence and insure to value all the time. It’s worth hiring an appraiser every once in a while to determine the true value of your property.