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Courtland Incorporated owns a $1 million office building which it insures under a Building and Personal Property Coverage Form with an 80 percent coinsurance provision. In an effort to reduce the premium, and assuming that it would never have a total loss, Courtland Incorporated decided to insure the building for $600,000. Ignoring any deductible that may apply, how much would the BPP insurer pay if the building suffered a covered loss of $100,000?
CPCU 500 explains that coinsurance is a policy condition designed to encourage insureds to carry insurance close to the property's value. If the insured carries less than the required amount, the insurer applies a coinsurance penalty on partial losses. The required amount of insurance is calculated as:
Property value coinsurance percentage.
Here, the building's value is $1,000,000 and the coinsurance requirement is 80%, so Courtland must carry at least:
$1,000,000 0.80 = $800,000.
Courtland only carried $600,000, which is below the required $800,000. Under the standard coinsurance formula, the insurer's payment (before deductible) is:
(Amount carried Amount required) Loss amount.
So the payment is:
($600,000 $800,000) $100,000
= 0.75 $100,000
= $75,000.
This result illustrates the CPCU 500 concept that underinsuring to save premium can create a significant out-of-pocket cost even on a moderate loss. Courtland would absorb the remaining $25,000 (plus any deductible, if applicable) because it did not meet the coinsurance requirement.