Coinsurance Penalty, the Mortgagee, and the Careless Tenant
A surplus lines property policy covers a Miami warehouse with a replacement cost value of $1,000,000. The policy carries a limit of $600,000, an 80% coinsurance clause, and a $5,000 deductible. The insured's bank is named as mortgagee. In June a fire caused $300,000 in damage. Investigators determine the fire started in a forklift operated negligently by the insured's tenant, who leases a portion of the building. The lease contains a mutual waiver of subrogation between landlord and tenant. The insured assumed its $600,000 limit was adequate because "the building would never burn to the ground."
1. Calculate the insured's recovery. Show the coinsurance calculation and explain the principle that drives it.
Read the worked answer
Step 1 - Insurance required to avoid the penalty 80% × $1,000,000 = $800,000
Step 2 - Did the insured carry it? Carried $600,000 ÷ Required $800,000 = 0.75 (75%)
Step 3 - Apply the ratio to the loss 0.75 × $300,000 = $225,000
Step 4 - Apply the deductible $225,000 − $5,000 = $220,000 payable
The insured absorbs $80,000 ($300,000 loss − $220,000 recovery).
The principle: coinsurance enforces the indemnity principle. The insured agreed to carry a stated percentage of the property's value in exchange for a lower rate. Carrying only 75% of the required amount means the insured is a 75% coinsurer of every loss - it shares the shortfall rather than transferring it to the carrier. Note that the penalty is computed on the loss, not on the limit, and that it applies even though the loss ($300,000) is well under the policy limit ($600,000). Had the insured carried the $800,000 required, the payment would have been $295,000.
2. The tenant caused the fire and the carrier would ordinarily subrogate. What happens here, and how does the mortgagee's position differ from the insured's?
Read the worked answer
Subrogation against the tenant
- Subrogation is the carrier's right, after paying the loss, to stand in the insured's shoes and pursue the party responsible. It exists to prevent the insured from recovering twice and to shift the loss to the culpable party.
- The lease's mutual waiver of subrogation defeats it. The insured contractually gave up the right to pursue the tenant for fire loss before the loss occurred; the carrier takes the policyholder's rights subject to that waiver. If the carrier wrote the policy without checking the lease, that is an underwriting/rating issue, not a recovery opportunity.
- If the tenant had been added to the policy as an additional insured, the result would be the same for a different reason - a carrier cannot subrogate against its own insured.
The mortgagee's position
- Under the mortgage clause, the mortgagee is protected independently: it is entitled to loss payment to the extent of its interest, notice of cancellation or nonrenewal, and it may pay premium if the insured does not. Its recovery is not reduced by the insured's acts or neglect - including the insured's coinsurance shortfall or misrepresentation.
- Practically, the carrier pays the mortgagee's interest first and the insured receives the balance. Because this is a surplus lines policy, no FIGA guaranty fund stands behind the carrier's promise, which is a point worth confirming with the bank at renewal.