Coinsurance and the Underinsured Hardware Store
Ridgeway Hardware owns a 40-year-old building with a replacement cost of $1,200,000 and an actual cash value of $900,000. Its commercial property policy has an $800,000 building limit, an 80% coinsurance clause, replacement cost coverage, and a $10,000 deductible. A fire damages the roof and electrical system. The cost to repair with like kind and quality is $300,000; the actual cash value of the damaged portion is $180,000. Ridgeway has not yet decided whether to repair and has no ordinance-or-law endorsement. The agent had recommended a $1,000,000 limit last year, but the owner reduced it to save premium.
1. If Ridgeway repairs the building, calculate the maximum building payment. Show the coinsurance math.
Read the worked answer
First calculate the required limit:
- 80% × $1,200,000 replacement cost = $960,000 required.
- Actual limit = $800,000, so the insured is underinsured.
Coinsurance formula:
(Limit ÷ Required) × Loss − Deductible
($800,000 ÷ $960,000) × $300,000 = 0.8333 × $300,000 = $250,000
$250,000 − $10,000 deductible = $240,000
Maximum payment if repaired: $240,000, subject to the $800,000 policy limit. The insured bears the $60,000 coinsurance penalty plus the deductible.
2. If Ridgeway chooses not to repair, what changes? Calculate the payment under the policy's valuation terms.
Read the worked answer
Replacement cost coverage generally requires repair or replacement. If Ridgeway does not repair, the insurer may settle on an actual cash value basis.
ACV coinsurance calculation:
($800,000 ÷ $960,000) × $180,000 = 0.8333 × $180,000 = $150,000
$150,000 − $10,000 deductible = $140,000
Payment if not repaired: about $140,000, not $240,000. The adjuster should confirm the policy's replacement-cost conditions, because some policies pay ACV first and hold back the replacement-cost difference until repairs are completed.
3. Is the $800,000 limit adequate? What should the agent document?
Read the worked answer
No. The limit is below the $960,000 required to avoid the 80% coinsurance penalty. The agent should document:
- The replacement-cost estimate and the recommended $1,000,000 limit.
- The owner's rejection and reason (premium savings).
- The coinsurance explanation and examples.
- Any signed rejection or acknowledgement.
Documentation does not eliminate the coinsurance penalty, but it reduces errors-and-omissions exposure and shows the insured made an informed choice.