Coinsurance; Coinsurance Formula; Property Coinsurance; Health Coinsurance

Coinsurance is a common provision in property and health insurance that helps to keep premiums affordable. In property insurance, coinsurance requires the insured to pay a certain percentage of his losses or expenses that is inversely proportional to the percentage of the property value insured. In health insurance, coinsurance requires the insured to pay a certain percentage of medical bills in health insurance so that the insured will shop around for lower prices.

Property Coinsurance

Coinsurance exists in property insurance because premiums are based on the frequency of loss and the amount. However, total losses are less frequent than partial losses, and therefore, the premium per $100 of property value will be less for a total loss than the premium per $100 of value for a partial loss. Without coinsurance, many people would only insure for partial losses, since partial losses are more likely to happen, and the premiums would be lower since the amount insured would be less. However, if insurance companies calculated premiums for partial losses, then people who wanted full coverage would be paying a higher premium than such coverage would otherwise command. Therefore, coinsurance helps to achieve equity in rating.

Some insurance companies use graded rates, instead of coinsurance, which are discounts that are proportional to the percentage of the property value that is insured. However, most companies do not use graded rates, because it requires a property appraisal and the appraisal may not be valid for long if property values fluctuate rapidly, as real estate does in hot markets, for instance.

Insurance companies require property to be insured by at least a certain amount—usually 80%—and if it is less than that, then the insured will have to pay a percentage of the loss equal to the percentage of his carried insurance over the required insurance. The 80% figure rather than the 100% figure is used to account for inflation. Since most property values rise over time, if there was a 100% requirement, and the insured purchased it, then a coinsurance payment may be required in a loss that occurs even 1 year after the purchase of insurance. However, if the insured paid for coverage that was greater than the value of the property, then he would be paying higher premiums than would be justified by the value of the property. But since insurance companies never pay more than actual cash value or replacement cost for the property, the insured would not benefit from overinsurance, which is paying for coverage that is greater than the value of the property.

Property Coinsurance Formula
Amount of Recovery =	Value of Loss	X	Amount of Carried Insurance ─────────────── Amount of Required Insurance	- Deductible

Example — Calculating the Property Coinsurance Payment

A business partially insures property worth $250,000 for $100,000, with a policy that requires at least 80% of its value to be insured for full coverage, and which has a $1,000 deductible, and then has a $20,000 loss. Since the amount of insurance required for full coverage = .8 x $250,000 = $200,000, the business would have to pay 1/2 of that loss, since the property was only insured for half of the required amount of insurance. Using the above equation, $20,000 x $100,000/$200,000 - $1,000 = $9,000.

Inflation and rapidly fluctuating property values can lead to a coinsurance payment even if the insured has chosen to fully insure his property. Property values can fluctuate widely and rapidly because of differing levels of inventory, for instance. To solve this problem, some insurance companies have a reporting form that allows the insured to update the value of the property as needed. Another solution is to provide an agreed value optional coverage, where the value for full insurance is agreed upon before any losses.

Another problem for the insured concerning coinsurance and inventory is the amount of effort that may be required to inventory both losses and remaining goods to determine whether a coinsurance payment will be required, so some insurance policies provide a waiver of inventory clause that stipulates that the insurance company will pay for any loss that is less than 2% of the value insured without the need to take inventory, thus, sparing the insured of a possibly significant task for a small claim.

How Coinsurance Yields Fair Premiums

Premiums are determined by the amount of loss and its frequency in a sample.
Property insurance premiums are based on $100 units of property value; therefore, the base premium is determined by the frequency of loss.
Partial losses are more frequent than total losses. Therefore, the 1st unit is always lost in any loss event, but the last unit of a property will only be lost if it is a total loss.
Therefore the premium needed to cover losses, if each $100 unit of value were considered separately, for the 1st unit would be much higher than for the last unit. The average premium needed to cover losses would decline continuously for each additional unit that is insured.
However, since underwriting risks and premiums are determined from actuarial studies of actual populations that records the total amount of losses and its frequency of occurrence, a premium rate cannot easily be determined separately for each $100 unit of property, and would be difficult to market, since a separate quote would be needed depending on how much of the property the insurance applicant wanted to insure.
If the premium were set to cover the 1^st unit of loss or the average loss, then people who wanted complete coverage would pay too much.
If the premium was determined that would insure the entire property, then many people would save money by insuring only part of the value of their property, since total losses are rare, in which case, the insurer would lose, because the premium would be too low for the risk.
Coinsurance allows insurers to quote a single premium that is contingent only on the amount. People who would insure for less than the required amount would have to pay a coinsurance penalty that is commensurate with the underinsurance.

Health Coinsurance

In economics, there is the well known relationship between supply and demand—when prices are up, demand is down, and vice versa. However, the law of supply and demand breaks down when payment is provided by a 3^rd party—in this case, insurance. If people don’t have to pay directly for a service, but, instead, have insurance which pays for the service, then there is little motivation to shop for the best prices. And since patients are unconcerned about price, doctors will raise their prices readily. This will, in turn, raise insurance rates for everyone, making health insurance even more unaffordable than it already is.

By making the insured pay a certain percentage of their medical bills, coinsurance, which is stipulated by the percentage participation clause in health insurance contracts, helps to keep premiums down by giving patients a vested interest in shopping for lower prices. Most policies require the insured to pay 20% or 25% of the medical bill above the deductible.

Another benefit to coinsurance is in the reduction of demand for medical services. When something is free, or nearly so, people tend to consume free services or products even when they do not need them. Coinsurance helps to prevent this waste by requiring the insured to pay not only the deductible, but also a significant percentage of the bill above the deductible. Thus, people will more carefully consider whether they really need medical treatment, and will be motivated to shop for better prices.