Understanding Coinsurance as It Applies to Business Interruption Insurance
Calculating the amount of coverage you need might take some doing.
Business interruption policies have significant coinsurance penalties for under-insuring. A coinsurance penalty is a deduction applied by the insurance company to the claim amount. The penalty can range from 20% – 50% of a loss.
Insurance policies define the amount of insurance coverage required in terms of “gross earnings” and many policies define “gross earnings” by a different method than your business accountant might.
Assume, your business has “gross earnings” as defined by the policy of $100,000. Assume your policy has a 80% coinsurance clause. Your business must purchase at least $80,000 in coverage . . . 80% of $100,000. This requirement is meant to prevent businesses from purposefully understating their income to reduce their premiums. If the business does not insure to 80% of its “gross earnings” in coverage, a coinsurance penalty will be applied.
The penalty is derived by dividing the amount of coverage actually carried by the amount required to be carried, and then multiplied by the loss.
For example; your business (referenced above) had a Business Interruption Insurance loss of $50,000, but had only carried $50,000 in coverage.
The amount of coverage actually carried divided by the amount required ($50,000 / $80,000) = .625.
Multiply that number times the loss (.625 x $50,000 = $31,250).
The Business Interruption Insurance carrier would only pay you $31,250 of your proven $50,000 loss, so your coinsurance penalty would be $18,750.
Insurers have become increasingly aware of the difficulty business-owners have with these policies. A number of years ago they combined several Time Element policies into one policy form and went to an Actual Loss Sustained form.
A large number of insurers now include in their policies what is called a Premium Adjustment Endorsement. If your policy does not have this, consider asking your underwriter or agent for the endorsement. The Premium Adjustment Endorsement helps eliminate the risk by allowing the business to insure for an outside loss possibility based on Gross Earnings. At the end of the policy period, the premiums are recalculated according to an audit, and any excess premiums are returned.
You need to make special considerations for seasonal businesses and a business that is rapidly growing.
Also see: Losses Covered By Business Interruption Insurance
Business Interruption Insurance Review
Business Interruption Insurance - Don't Be Caught Short!
Calculating Your Needed Coverage Amount for Business Interruption Insurance