One of the more confusing and overlooked risks in a business is the coinsurance clause included in most commercial property policies. As with most things applied incorrectly, coinsurance can do more harm than good, sometimes even leading to a complete closure of a business. This clause is especially important in manufacturing due to the high replacement cost of equipment, more so if you have custom machinery or machinery that is no longer available.
Coinsurance is a percentage of value that a business is required to carry by the insurance carrier. This can range from 80-100% of the replacement cost of the business. If the property is insured for less than the amount required your insurance company will impose a coinsurance penalty.
The equation used to determine the amount you will receive in the event of a loss is straight forward and looks like this:
Example A: Company A has some old machinery from the nineteen eighties that does a perfect job manufacturing widgets. The company paid $1 million dollars in 1980 for the equipment. In 2016, the machinery, although it is no longer on the market, is maintained meticulously & the parts are custom replaced as needed. The cost to replace this machinery with similar capabilities in the event of a loss today is $2 million dollars. The equipment is currently insured for $1.6 million dollars (80% of the replacement cost of $2 million dollars) with an 80% coinsurance clause.
If the company has a fire that destroys some of those machines and the cost to replace and repair the equipment is $500,000, using the equation above, company A has the proper amount of insurance and is paid the full $500,000 for the machines.
If however, company A only carries $1.2 million dollars of insurance (60% of the replacement cost of $2 million dollars) with an 80% coinsurance clause, the same loss of $500,000 would result in a penalty for not meeting the 80% clause. They would only receive $375,000 of the loss and would have to cover the remaining $125,000 out of their bottom line.
This unfortunately is a scenario that is not fully explained to the client or evaluated by the business when purchasing insurance. Many times it is completely overlooked due to bidding and quoting by multiple agents in order to receive a better price.
It is the job of your insurance agent to help you identify risk to your business. With the right broker you can address risk and have the right coverage for your business that properly protects you in the event of a loss.
Have you checked what your coinsurance requirements are and are you meeting them? How would a loss like this affect your company? Will you be able to open your doors again? If so, how will it affect your business and its ability to compete? If you do not know the answer to any of these questions call our offices today to schedule an appointment to have your policy reviewed.
