The Split-Limit Warehouse Fire
Northline Storage Ltd. owns a 12,000 sq ft warehouse in a mid-sized city. Its property policy has a blanket building limit of $2,400,000, a contents limit of $600,000, a $10,000 deductible per occurrence, and a coinsurance clause of 80%. The building's replacement cost is appraised at $3,200,000; Northline has carried the $2,400,000 limit unchanged for four years because the broker said it was 'close enough.' A fire in March destroys the roof structure and 40% of the racking and stored goods. The adjuster's replacement cost estimate for the damaged building portion is $1,100,000, and damaged contents replacement cost is $250,000. The building is repaired for $1,050,000 and contents are replaced for $240,000. Northline's CFO insists the claim should pay the full repair cost because 'we insured three-quarters of the building's value.'
1. Determine whether a coinsurance penalty applies to the building loss, calculate the payable amount, and explain the reasoning to the CFO.
Read the worked answer
A penalty applies. The coinsurance requirement is 80% × $3,200,000 = $2,560,000. The carried limit is $2,400,000, so the insured is at 75% of value ($2,400,000 ÷ $3,200,000), which is below the 80% requirement.
Because the policy is written on a replacement cost basis and the loss is partial, the penalty is applied to the loss, not to the full limit. The standard formula is:
(Insurance carried ÷ Insurance required) × Loss, capped at the policy limit.
$2,400,000 ÷ $2,560,000 = 0.9375. Applied to the $1,100,000 replacement cost of the damaged portion gives $1,031,250. The actual repair cost of $1,050,000 is irrelevant to the penalty calculation because the loss is measured by the replacement cost of the damaged property, not by what the contractor happened to charge. The result is then reduced by the $10,000 deductible: $1,021,250.
The CFO's premise is wrong in two ways. First, 'three-quarters of value' is measured against the 80% requirement, not against 100% of value, so the shortfall is smaller than it appears but still real. Second, the penalty is not a forfeiture of the whole claim; it is a proportional reduction that puts the insured in the same position it would have occupied had it insured to the requirement. The practical fix is to raise the limit to at least $2,560,000, or to buy agreed-value or margin clauses that suspend coinsurance.
2. The contents limit is $600,000 against a contents replacement value of $900,000. Calculate the contents payment and discuss how the deductible interacts with the two payments.
Read the worked answer
Contents are also underinsured. Required amount = 80% × $900,000 = $720,000. Carried = $600,000, so the ratio is $600,000 ÷ $720,000 = 0.8333. Applied to the $250,000 replacement cost of damaged contents gives $208,333.
The deductible is applied once per occurrence, not once per coverage part, so the two payments are combined and a single $10,000 deductible is subtracted, assuming both losses arise from the same fire. Total before deductible: $1,031,250 + $208,333 = $1,239,583. Payable after the $10,000 deductible: $1,229,583.
Two points deserve emphasis. First, the contents ratio is worse than the building ratio (83.3% versus 93.75%), so the contents shortfall costs proportionally more. Second, if the policy's deductible clause states that the deductible applies separately to each coverage part, the adjuster would instead subtract $10,000 from each payment, producing $1,021,250 + $198,333 = $1,219,583. The wording of the deductible clause, not general practice, controls. The insured should also confirm whether the policy includes a margin clause, which caps recovery at a stated percentage of the reported values and can produce a different result than the coinsurance formula.