It is important when insuring a property that proper steps are taken to arrive at the actual value of the property. Failure to do so might result in some very unpleasant situations if it so happens that something does happen to the property. If a property was under-insured, the insured would incur a penalty.

The subject of insurance to value is not easily understood by most people seeking to insure their properties. It's easier to understand if we relate it to the replacement value of a property. Basically, insurance to value serves to encourage those seeking to insure their properties to sign up for an insurance amount reasonable in relation to the replacement value.

How Insurance to Value Works

When a policyholder fails to buy adequate insurance to satisfy the insurance to value percentage stated in their policy, the coinsurance clause takes effect. Please note that this clause only comes into play when there has been a partial property damage loss. In such instances, the insurance provider compares the insurance limit on the policy in question to the amount the policyholder was supposed to buy.

If the policyholder purchased less insurance than required, the insurer might reduce the claim in proportion to the difference. If the policyholder purchased 10% less than they should have, then the insurer might pay an amount that is 10% less than the claim. 

Why is Insurance to Value Important

In most instances, it rarely happens that an insured property is damaged totally. Usually, only a section of the property gets damaged, and with some repair work, the property will be restored to its original form. There are many people who are aware of this. As a result, they are reluctant to insure their properties for an amount that is close to equal to the replacement value. To them, there is no reason to do that since there is a slim chance that the entire property will be damaged.

Insurance to value requirement of the coinsurance clause pushes homeowners to purchase adequate insurance. If they didn't exist, many people would attempt to cheat their way out of paying premiums and insure their properties for less than their actual value. All these people would have less than enough insurance to cover significant losses.

For instance, let's say that we have a homeowner A. Upon consulting a building contractor, the home's replacement cost is estimated to be $3 million. The homeowner purchases a property insurance policy that does not meet the 80% insurance to value. In such instances, the recovery amount will be based on a percentage of the insured amount instead of the actual cost of replacement.

Please consider the following situation

●     The full replacement value of a home is $400 000

●     The insured has a policy of $250 000

●     The total cost of repairing a damaged ceiling is $4,500

●     The policy has a deductible of $500

For the insured to comply with the coinsurance clause, they should insure the home for a value of 80%, which is $320 000 in this instance. This means that since the insured only has a limit of $250 000, they did not meet this requirement and incur a penalty.

To arrive at the amount payable, use the following formula:

(insurance carried / insurance required) x replacement cost of roof

$250,000 / $320,000 = .78

Actual loss is $4,500 less the deductible of $500.  Normally the insured would receive $4,000.  However, because they did not meet the coinsurance requirements, they will apply a penalty. $4,000 X .78 = $3,120.  Instead of receiving the $4,000, they would only be eligible for $3,120