Coinsurance Math on the Kona Building (and the Client Who Wants Less Insurance)
Kimo owns a 40-year-old commercial building in Kailua-Kona insured under a commercial property form with an 80% coinsurance clause, a $5,000 deductible, and a building limit of $1,200,000. A windstorm tears off part of the roof; the repair estimate is $400,000, and the insurer agrees the building's replacement cost at the time of loss is $2,000,000. Kimo's business income coverage carries a 72-hour waiting period; net income plus continuing expenses run about $40,000 a month, and the restoration will take four months. Kimo asks his agent to cut the building limit at renewal because the premium jumped 22% after the windstorm.
1. Compute the building payment and explain the gap to Kimo in plain terms.
Read the worked answer
Required limit to avoid penalty: $2,000,000 × 80% = $1,600,000.
Limit carried: $1,200,000, which is 75% of the requirement ($1,200,000 ÷ $1,600,000).
Payment: $400,000 × 0.75 = $300,000, less the $5,000 deductible = $295,000.
Kimo absorbs $105,000 of coinsurance penalty ($400,000 − $300,000) plus the deductible - $110,000 of a $400,000 repair.
Had he carried $1,600,000, the loss would have paid $400,000 − $5,000 = $395,000.
Explanation to the client: coinsurance is a promise to insure to a stated percentage of replacement cost, and the percentage is measured against replacement cost at the time of loss - not the price he paid for the building and not its market value. The test is applied at loss time, so a limit that was adequate when written can fall short after construction-cost inflation. It is not a penalty the insurer invented; it prices the retained risk that came with the lower limit. Note too that the shortfall is a one-time loss, while the premium savings were spread over years - the trade is worth restating with these numbers.
2. Estimate the business income payment and flag the assumptions that could change the answer.
Read the worked answer
Estimate: about $156,000.
$40,000 per month ÷ 30 days ≈ $1,333 per day of combined net income and continuing expenses. Four months ≈ 120 days → $160,000 of lost business income. The 72-hour waiting period removes roughly 3 days (≈ $4,000). $160,000 − $4,000 ≈ $156,000.
Assumptions to verify:
- Limit adequacy. Check the business income limit against the projected total ($40,000 × 4). Business income limits are frequently set at a fraction of annual figures without much thought, and some forms carry their own coinsurance or monthly-limitation provisions.
- Period of restoration ends when the property could reasonably be repaired with due diligence, not when Kimo reopens; delays caused by permit or ordinance upgrades may be outside the period.
- Extra expense is separate from business income and may also be triggered (temporary space, expedited materials).
- An extended period of indemnity endorsement, if present, adds days after restoration; if absent, the day the roof is done is the day payments stop.
- Damage from mold or ordinance-required upgrades should be checked against specific sublimits rather than assumed covered.
3. Kimo wants the limit reduced at renewal. What should the agent do, and why is the request dangerous?
Read the worked answer
Reducing an already-inadequate limit sharpens the coinsurance penalty - the ratio in the denominator ($1,600,000 today, and higher after another year of cost increases) does not move down with the limit. At $1,000,000 the ratio drops to 62.5%, so a $400,000 loss pays $250,000 before the deductible: Kimo absorbs $150,000 of a repair he could otherwise fully collect.
The agent should:
- Re-run the coinsurance math in writing using current replacement cost, showing the penalty at the proposed limit for several loss sizes.
- Present the legitimate premium levers: higher deductible, actual cash value on the older structure, agreed value (which suspends coinsurance for a scheduled amount), or restructuring the roof as a separate schedule.
- Confirm the mortgagee or lender's minimum requirement, if any -a lower limit may violate a loan covenant.
- Document the advice and the client's decision. If Kimo still elects the lower limit, a signed declination in the file is the difference between a documented client choice and an errors-and-omissions claim after the next claim.
- Avoid presenting the lower limit as a premium solution; present it as a risk-retention decision with a dollar cost.