Homeowner's Insurance Details - The Coinsurance Penalty

Coinsurance laws are in place to prevent you from under-declaring the value of your home then making large claims. The coinsurance requirement stems from the belief that insurance companies are essentially risk pools. They allow a community of people to come together and split the costs of repairing unforeseen damages to homes and other properties. When one person under-declares the value of his or her home, the whole community will suffer. This means there will be a penalty for under-declaring.

How Coinsurance Works

Coinsurance works by preventing you to receive a 100% payout for a claim if you did not declare 100% of the value of your home on your insurance policy. You cannot escape higher premiums by undervaluing what you own. If you do this, then your limits will not cover the loss you actually incur when a claim is necessary. Coinsurance basically prevents you from attempting this technique by preventing you to recover in full unless you declare in full. As the value of your home goes up over time, your coinsurance will go up unless you raise your insurance premium as well. Unfortunately, one of the costs of owning a home, especially a pricey home, is expensive insurance.

How Coinsurance Is Calculated

If you only insure a portion of your home's value, then only a portion of your losses will be covered. Consider the following example:

  • Your home is worth $200,000
  • You declare your home's value to be $150,000 on your insurance
  • You are only insuring, in actuality, 75% of your home
  • You have a claim for a $20,000 loss in damages from a windstorm to your roof
  • Your insurance company will only cover 75% of the claim, or $15,000
  • The $5,000 of the claim that is not covered is called the coinsurance penalty

If the insurer were to pay out your entire claim, then the insurer would lose money over time. When an insurer loses money, the company has to raise premiums for everyone on the policy. This would be unfair to those people who are already paying the maximum amount on their premium. Instead of doing this, the insurer will only penalize you on a case-by-case basis.

Avoiding Coinsurance

Some people choose to keep the value of their home low on an insurance contract. They simply accept the coinsurance premium. They feel, over time, their low number and low value of claims will make up for the money they have to spend out of pocket on occasion. This is one method to reduce costs. However, if you do have a huge claim, say a fire destroys your home, then you will be out 25% of the value of your home in the above example. You can protect yourself from this and still keep your premiums low by opting for a high deductible instead. You will have to pay a portion of your claims out of pocket when you have a high deductible. However, in the case of total loss, you will have more to gain than if you simply leave a portion of your home uninsured.