Insurable Interest, Indemnity, and Valuation
Insurable interest
Insurable interest is a legal or equitable relationship to property such that the insured benefits from its continued existence and suffers loss from its destruction. It must exist at the time of loss for property insurance (contrast life insurance, where it is tested at inception). Ownership, mortgagee interest, bailee interest, and tenant improvements all create insurable interest.
Indemnity and valuation
Indemnity restores the insured to the pre-loss financial position - no better, no worse. Actual cash value (ACV) is typically replacement cost less depreciation; replacement cost pays to rebuild with new materials of like kind and quality without deduction for depreciation, subject to limits. Agreed value fixes the value in advance. Functional replacement cost substitutes modern materials of equivalent function.
Coinsurance and the trap
A coinsurance clause requires the insured to carry insurance to a stated percentage of value (commonly 80%). The recovery formula is:
(Insurance carried ÷ Insurance required) × Loss = Payment, capped at the policy limit.
Traps: applying coinsurance to a total loss (the limit caps it), forgetting that coinsurance does not apply when the limit equals or exceeds the requirement, and confusing coinsurance with a deductible.
Worked example
Building value $1,000,000; 80% coinsurance; limit carried $600,000; loss $200,000. Required = $800,000. Payment = (600,000 ÷ 800,000) × 200,000 = $150,000, less deductible. If the limit had been $800,000 or more, the full $200,000 would be payable (subject to the limit and deductible).
Rule of thumb
Always compute the coinsurance requirement first, compare it to the limit, then apply the ratio only if the limit is short.