Do Your Homework on Coinsurance
Coinsurance can be costly if you don’t understand the penalties.
You’re a savvy investor. You make sound, confident decisions about the properties you’ve added to your portfolio. And your strategy has been successful. Yet even the most successful real estate investors can be snagged by the penalties associated with valuation and coinsurance, outlined in the fine print on your insurance policy.
If you’re like most bullish investors, you’re probably heavily leveraged and work with lenders when acquiring new properties. Every dollar counts. You know that the lower your property is valued, the lower the insurance premium you will pay to cover it. You may have bargained for a great deal to acquire your property and you’ve calculated that should something happen, it may cost even less to replace the property. But, your insurer may put a higher replacement value on your property.
That’s as it should be because you can’t rebuild to even the current property status for your purchase price.
Discrepancies in valuation have become one of the biggest challenges in the property insurance industry. Gone are the days of guaranteed replacement cost policies where properties were simply replaced outright, no matter what. Mass damage from events such as hurricanes put an end to those offerings. They also put several smaller insurance carriers out of business. To compensate, today most insurers require your property to be coinsured for most of its replacement value.
What Is Coinsurance?
What is a coinsurance requirement? Although the term is used widely, sometimes it is confused with “copay.” And the term takes on a very specific meaning in property insurance.
Coinsurance is the percentage of value you are required to insure against the value of your property. Usually, this is around 80%, and it is a typical bank lending requirement for most loans. The tricky part is that the replacement value is determined by your insurance company only after the damaging incident. But if you insured your property for less than the coinsurance percentage to pay a lower premium, then you will be hit with a coinsurance penalty. This amount can be costly at best and put you out of business at worst, especially if you have several properties impacted by weather or other events simultaneously.
To help clarify, here’s an example:
- You own a multifamily rental property that you calculate can be replaced for $375,000.
- Your insurance carrier is requiring you to have at least 80% in coverage.
- You purchase $300,000 in coverage (80% of value), believing you are compliant.
- Suddenly, you have $100,000 in damage.
- But your insurer determines the replacement cost is $500,000.
- Your insurer will calculate how much to pay on the claim by dividing the coverage amount you bought ($300,000) by what you should have purchased (80% of $500,000, or $400,000 in coverage). In this case, it comes to 75%.
- So, for your claim of $100,000, you will only receive $75,000 (75%).
- The $25,000 difference is your coinsurance penalty.
Again, the difference in value is key. Not knowing the replacement value that your insurer places on your property is one of the most surprising and costly issues investors at all levels face. This is not also calculating in any deductible amount. Although our example uses a coinsurance requirement of 80%, some policies require even more—up to 90% or 100%.
Protecting Yourself
To overcome the replacement value issue and avoid a costly penalty, the best practice is free and easy—talk with your agent. Here’s what you need to ask:
1) Does your policy have a coinsurance penalty? (Most do)
2) How much is your coinsurance penalty?
3) What is your property’s replacement value?
4) Have you properly insured your property?
5) Are there any special requirements, such as coverage for floods?
A sound agent will be completely transparent on your behalf and will tell you about any penalties you may not know about. Some insurance carriers will allow you to remove the coinsurance penalty—for a fee. In many cases, the additional cost to have it removed may be worth it in the long run.
It’s also important to know that not all policies are the same. More mainstream insurance carriers may offer very general policies and try to make them seem all-inclusive. Some of these are called “basic” or “named peril” policies.
The general policies have two lists: what is covered and what is excluded. It’s always better to work with an agent who specializes in property insurance. Ask whether a “Special” or “All Perils” policy is better for you. This type of policy may include waivers for things like water damage and theft. They cover all risks—unless they are explicitly called out on its list of exclusions. Special policies often cover significantly more than basic policies. Again, an experienced property insurance agent can fully answer your questions and will advise you on which type of policy is best for you. A reputable agent won’t try to win your business at the lowest price. As with many things in life, you will get what you pay for when it comes to property insurance coverage. Doing your homework will always pay off.
