Small-business owners shopping for liability insurance for the first time often come across a number of unfamiliar terms and industry jargon. This language can lead to confusion, making the insurance-buying process much more complicated and frustrating than it needs to be. One of our goals is to demystify the language of insurance to make life easier for our customers. Without further ado, here’s a plain-English definition of one of the terms we get the most questions about: coinsurance.
The Two Meanings of Coinsurance
Coinsurance is a tricky term in part because it can mean two different things:
1. Insurance provided by multiple parties. When two or more insurance providers jointly cover a person or entity, their coverage is called coinsurance.
2. Coverage guidelines issued by an insurance provider. Some insurance companies require customers to carry policies that have a limit that is related to the value of the property they want covered. For example, if you have property worth $100,000, your insurer might have a coinsurance clause that requires you to carry coverage of at least 80 percent of the value of your property, (i.e., a policy with a limit of at least $80,000.
For most small-business owners, the second definition is the one that matters.
How Do Coinsurance Clauses Work?
In a typical General Liability policy, a coinsurance clause ensures that you carry adequate coverage to protect your possessions. Let’s take the same example from above: say you have $100,000 in assets and your insurance policy includes a clause that requires a coinsurance rate of at least 80 percent.
If you opt to purchase less coverage (e.g., a policy with a $50,000 limit), the insurance company typically reserves the right to pro-rate any coverage it gives you. Translation: if you fail to meet your coinsurance limit, then suffer property damage and make a claim, the company may not pay out the full value of your damages, even if they fall within the limits of your policy.
If, for instance, a storm hits you and causes $40,000 worth of property damage, your Property Insurance policy with a limit of $50,000 might not cover the full cost if it doesn’t meet the coinsurance guidelines set by the insurer. Instead, it would provide coverage only for a certain percentage of the losses you face.
Why Do Insurance Companies Have Coinsurance Clauses?
Not every insurance company includes a coinsurance clause in its policies. Those that do require coinsurance, however, typically have three reasons for doing so:
- To ensure clients have adequate coverage. This is perhaps the most important. It’s kind of like how parents make you eat vegetables: even though you may not want to do it when you’re a kid, you’re glad for the health benefits in the long term. With insurance, you may not want to fork over enough money to cover all of your assets, but if you ever need coverage, you’ll be happy you invested in adequate protection.
- To protect their pool of resources. If your business has lots of assets, it has lots of opportunities for damages that lead to an insurance claim. Requiring you to buy insurance that matches your risk exposure means the insurance provider is better equipped to handle real-world claim situations.
- To encourage accurate assessment and underwriting. When you’re required to meet coinsurance limits, you’re more likely to make an accurate assessment of the value of your assets, which benefits the insurance provider (and you) in the long term.