Agreed Value Option to Avoid Coinsurance

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Many commercial property policies include an optional coverage called agreed value. This coverage suspends the coinsurance clause in the policy. If a loss occurs and you have elected agreed value coverage, your insurer will not consider coinsurance when calculating your loss payment. Agreed value coverage will apply only if you have fulfilled certain requirements. These are outlined below.

Coinsurance Penalty

The coinsurance clause is designed to encourage property owners to purchase an adequate amount of insurance.

Policyholders dislike this clause because it imposes a penalty for underinsurance. When coinsurance is applicable, your policy will specify a coinsurance percentage, such as 80% or 90%. The number represents the amount of insurance you must maintain. This amount is expressed as a percentage of the value of your insured property.

For example, suppose that you have just purchased a commercial property policy that includes a 90% coinsurance percentage. The policy covers your building and personal property. These are valued at $2 million and $500,000, respectively. You have satisfied the coinsurance condition by purchasing the required limits of insurance. These are $1.8 million on your building and $450,000 on your personal property.

Penalty Determined at Time of Loss

A primary problem with the coinsurance clause is the timing of the penalty. Your insurer evaluates your policy limits at the time loss a loss occurs.

In the previous example, you satisfied the coinsurance requirements in your policy when you purchased the coverage. However, the value of your property may increase during the policy period. If you have failed to purchase additional insurance and a loss occurs, your limits may fall short of the amount required by the coinsurance clause.

You may be subject to a coinsurance penalty.

Property can increase in value for a number of reasons. Personal property, such as furniture or computer equipment, may increase in value because you have acquired more of that property since your policy was issued. Buildings may increase in value during the policy period due to inflation, rising construction costs, or a hot real estate market. You may not be aware that the value of your property has increased until a loss occurs.

Agreed Value Option

As its name suggests, an agreed value is a property value that you and your insurer agree upon at the beginning of your policy period. To obtain coverage based on an agreed value, you must submit a statement of values to your insurer before your policy begins or renews. A statement of values is a list of your insured property (buildings and personal property) that includes the value of each item. Property values should be expressed in terms of replacement cost or actual cash value, whichever applies under your policy.

A statement of values is normally prepared on a standard form provided by your insurer. Ask your agent or broker for assistance if you need help completing the form.

Once you have provided a statement of values to your insurer, the coinsurance clause in your policy will be suspended for one year (the term of your policy).

To continue agreed value coverage the following year, you must submit a new statement of values before your current policy expires. If you fail to provide one, the coinsurance clause will be reactivated.

Must Maintain Proper Limits

To obtain protection from coinsurance under the agreed value clause, you must maintain limits equal to the agreed values. That is, if your statement of values indicates that the cost to replace your building is $2 million, you must maintain a building limit of at least $2 million. If a loss occurs and you have failed to maintain the limits shown in your statement of values, you may be stuck paying a portion of the loss. 

Under the agreed value clause, the most your insurer will pay for a loss to damaged property is the proportion that the limit for that property bears to the agreed value for that property shown in the statement of values.

For example, suppose that the replacement cost of your building is listed as $2 million in your statement of values. You have insured your building for only $1.5 million. Your policy includes a $1000 deductible.

A severe hailstorm causes $100,000 damage to the roof of your building. You have failed to insure your building at the $2 million replacement cost. Thus, your insurer will not pay the loss in full. Your insurer will pay only $74,000. Here is the calculation:

$1.5 million divided by $2 million = .75

.75 times 100,000 loss = $75,000

$75,000 less the $1,000 deductible = $74,000