Coinsurance Arithmetic on the Kenai Warehouse
Kenaicraft Storage LLC owns a single warehouse in Kenai. The building's replacement cost at the time of loss is $1,200,000. Its commercial property policy carries a $720,000 building limit, an 80% replacement-cost coinsurance clause, a $5,000 deductible, and replacement cost settlement conditioned on repair or replacement. Fire damages one bay; the replacement cost of the damaged portion is $300,000 and its actual cash value is $180,000. The owner set the $720,000 limit by adding the land's $480,000 assessed value to the building value. The company also has $90,000 of business income exposure but carries no business income coverage. Repairs are completed within four months.
1. Compute the building payment under the replacement cost form. Show each step and check it against the policy limit.
Read the worked answer
Step 1 - required insurance: 80% × $1,200,000 (RC value at time of loss) = $960,000
Step 2 - the coinsurance ratio: $720,000 carried ÷ $960,000 required = 0.75
Step 3 - apply the ratio to the loss: 0.75 × $300,000 = $225,000
Step 4 - subtract the deductible: $225,000 − $5,000 = $220,000
Step 5 - cap check: $220,000 is below the $720,000 limit, so the limit does not further reduce payment.
Why this hurts: the insured carried 75% of the required amount and therefore collected roughly 75% of the loss. Every dollar of underinsurance is paid twice - once in the penalty and once in the uninsured remainder.
If the insured had not repaired or replaced: settlement converts to ACV and the same ratio is applied to the ACV loss (0.75 × $180,000 = $135,000 − $5,000 = $130,000), with the difference recoverable if repair is completed within the policy's time period.
2. Would the answer change if the owner had selected actual cash value settlement instead of replacement cost? Explain what the coinsurance clause is actually measuring.
Read the worked answer
Yes, and only in step 3. Under ACV the loss is $180,000, so payment is 0.75 × $180,000 = $135,000 − $5,000 = $130,000.
The ratio itself does not change, because the coinsurance clause measures something different from the loss: whether the limit bears the required proportion (80%) to the value of the whole property at the time of loss. It is a value-of-the-risk test, not a value-of-the-claim test.
Two practical consequences:
- The choice of RC versus ACV form changes the loss figure the penalty multiplies and usually changes the value figure the 80% is applied to (RC value is higher than ACV, so an RC form demands a bigger limit for the same building).
- A settlement clause never repairs an underinsurance problem. The only fix is a limit at or above 80% of the value - here $960,000. Note the marginal economics: the premium on the extra $240,000 of limit would have produced roughly $75,000 of additional recovery on this one loss.
3. The owner says the $90,000 business income loss should come out of the property limit because "the building is the business." Address the gap and what the agent should have documented at application.
Read the worked answer
The building limit pays for direct physical damage to the building only. Business income - the net income and continuing normal operating expenses during the period of restoration - is a separate coverage triggered by direct physical loss at the described premises and written with its own limit, its own period of restoration, and usually a 72-hour waiting period.
Consequences here:
- The $90,000 is uninsured. It is neither payable from the building limit nor recovered through the coinsurance penalty. No coverage can be created after the loss.
- Watch for forms that include limited "civil authority" or extended business income coverage - but those are extensions inside a business income form the insured does not own.
What the file should show:
- A completed underwriting submission with the correct building replacement cost - not the assessed value including land. Mixing land into the limit is the root cause of both this gap and the coinsurance penalty.
- A written offer of business income coverage with a recommended limit derived from projected income plus continuing expenses and a realistic restoration period (four months of construction may become eight in an Alaska winter).
- A signed declination if the insured refused.
That documentation does not change the claim, but it defines whether the agency or the client bears the loss.