What is a coinsurance penalty?
First, I need to say the homeowners' coinsurance is not applied in the same manner as medical insurance. The insurance company does not pay 80% of your loss and then you are responsible for the other 20%.
Secondly, most homeowners' policies do not even contain the term "coinsurance". The portion of the policy which some call the coinsurance clause is actually referred to within the industry as an "insured to value clause". By purchasing this policy you agree to insure your home for an amount of no less than 80% of the home's replacement cost value.
This is how the "insured to value clause" works. You agree to insure your home for no less than 80% of the replacement cost value on the building immediately before the loss. In order to do this, you must know how much it will cost to totally rebuild your from the ground up. Remember, the replacement cost value is not what you paid for the property originally nor is it how much you could sell your home for today. It is what the repairs will cost to restore your home back with like kind and quality in the event you experience a total loss, and if you fail to insure your home to the proper value, YOU MAY BE PENALIZED.
Here is the formula the insurance company uses to determine if you insured your home correctly.
Did ÷ should = % x amount of the loss – the deductible = the amount due
You take the amount for which the home is insured and divide it by the replacement cost value of the home. This will result in a % amount. If that % amount number is 80% or more, you can stop. Your home is insured to value, and a coinsurance penalty will not be applied to your loss.
If that % amount number is less than 80% you will then multiply that % number by the amount of the loss. You will then subtract your deductible and that will result in the amount due*. See below.
You insured your home for: $100,000.00
You should have insured it for: $200,000.00
You have a loss which totals: $50,000.00
Your deductible was:: $1,000.00
$100,000.00 / 200,000.00 = 50% X $50.000= $25,000.00 - $1000.00 = $24,000.00
As you can see in the above example, the insured did not purchase enough insurance and their $50,000.00 claim suddenly turned into a $25,000.00 claim. The insured could receive a coinsurance penalty of $25,000.00. Bummer!
*Most policies allow for the insured to be paid the greater of this amount or the actual cash value of the loss.