As a way to help manage insurance premium rates, insurance companies use several ways to mitigate the impact of a loss against an insurance policy.

  1. One way to do this is to make the peril in question ineligible for any coverage, i.e. flood insurance under a homeowner’s policy.
  2. A second way is to make it a peril eligible but only after a waiting period determined by policy benefits, i.e. hospital inpatient care.
  3. A third way is limited number of days coverage will be provided, i.e. extended outpatient care of 121 days.
  4. A fourth is the use of deductibles before any coverages are eligible for coverage.
  5. A fifth is the co-insurance provision above and beyond any of the methods mentioned.

In all types of property insurance premiums, the amount of co-insurance has a major impact on what the premium is going to be. An example: Your home is estimated to be worth $300,000 if it was to be totally destroyed. The insurance company upon issuance of a fire policy immediately accepts the total $300,000 liability; but the chances of you having a total loss throws a monkey wrench into the actuarial equation. Recognizing this, the insurance company issues a decree that if you will keep your home insured to 80%, in the event of a partial loss, the company will pay the total minus the deductible. If your insurance drops below 80% of value and you have a partial loss, then only the amount equal to the percentage amount of coverage will be paid, i.e. $300,000 total value home insured for $200,000 with a $10,000 loss. Since 80% of the total is $240,000 only $6,666 of the $10,000 loss minus deductible would be paid. If on the other hand you had kept home insured to $240,000 the full $10,000 minus deductible would have been paid.

In commercial coinsurance percentages are factored into the initial premium being quoted.  The closer one gets to insuring at 100% of replacement value, the lower the premium will be per $1000 coverage. Some premiums are figured at 90% or 80% thus having a higher premium per $1000 being paid. The rationale is one does not know what part of the 100% insured structure is going to be damaged, but the insurance company is collecting premium for the potential of total loss so is collecting more premium. With the coinsurance provision being met, partial losses will be paid in full under any co-insurance provision so the only risk for insuring at a percent less than 100% is if you are insuring at 80% 0r 90% and have a total loss.

Part of the responsibility of the risk manager is to determine how much the company wants to participate at the time of loss as opposed to paying a higher premium over time, thus reducing the amount to be paid at the time of loss. Decision time!