‘Coinsurance’ or ‘Average Clause’ Explained and Case Study

Coinsurance Clause or Average Clause

An insurance policy for a property owner is accompanied by a detailed and complex contract that will contain clauses, provisions and responsibilities that are assigned to either the policy holder or the insurer.

One of these provisions is the coinsurance clause.

Coinsurance is quite often misunderstood and it inclusion in a policy can have astounding ramifications and financial exposure to the policy holder.


What is Coinsurance?

Coinsurance is also known as the Average Clause. It is a common clause contained in most Commercial Property Insurance Policies.

Coinsurance is quite commonly used within insurance policies covering buildings, equipment, business contents, inventory, and other property.

These policies insure your property for ‘Replacement Value’.

The clause generally ensures that policy holders carry an appropriate amount of insurance coverage and receive a fair premium for their insurance policy.

In the event that a policy holder fails to correctly insure their property for the full replacement value, then they are deemed to be ‘sharing’ the risk of the insured asset with the insurer.

The inclusion of the coinsurance clause is to encourage clients and policy holders to make sure they have a sum insured that is adequate to obtain the maximum protection from the policy.

In the event that a policy holder does not have adequate insurance to cover the full replacement of the property (intentional or unintentional), the insured person will be required to pay a share of the payment made against a claim.

For this reason, it is extremely important that your Sum Insured reflects the true replacement cost of your property/items.

Most policies allow a sum insured that is within 80% of the replacement value without the clause coming into effect. It does change from policy to policy, so it is best to actually understand what the percentage is within the insurance policy, and better still, avoid this all together by insuring it for the correct sum.

Most coinsurance clauses require policyholders to insure to 80, 90, or 100% of a property’s actual value. For instance, a building valued at $1,000,000 replacement value with a coinsurance clause of 90% must be insured for no less than $900,000. The same building with an 80% coinsurance clause must be insured for no less than $800,000.

If the sum insured is below the 80% then it is deemed the policy holder is under insuring and ‘average’ is applied.

If the policy holder chooses to insure the building for less than $800,000, they agree to retain part of the risk with the insurance company.

Put simply, the % of your sum insured as it relates to the Replacement Value is applied. The effect of this can be catastrophic to any business.


How the Coinsurance Formula Works

The coinsurance formula is calculated by dividing the actual amount of coverage on the property by the amount that should have been carried for the replacement value.

So, if you have insured your property for $750,000 and it should have been $1,000,000, then you are insured for 75% of its value.

Current Insured Value    ÷             Actual Real Value             =             Your Insured %

$750,000                       ÷                 $1,000,000                =                                75%

Then, multiply this amount by the amount of the loss, and this will give you the amount of the reimbursement.

Coinsurance does not apply to total loss claims only, it will apply to partial damage as well.

If the above-mentioned property of $1,000,000 suffered roof damage and a new roof was required then the policy holder would submit a claim.

The formula to determine the recovery is based on the property’s replacement value at the time of loss. If the replacement amount is less than the coinsurance percentage, a penalty is applied, reducing the claim payment.

For example, a policyholder has $750,000 of property insurance and a storm causes $200,000 in roof damages.

The claim is calculated by dividing the amount of insurance purchased ($750,000) by the value at time of loss ($1,000,000). This factor (75 per cent) is multiplied by the amount of the loss ($200,000).


Amount of Loss Value    x              Insured Percentage %    =             Your Payment Value

$200,000                      x                            75%                   =                             $150,000


In this example, the policyholder would receive $150,000 (less any deductible) for a $200,000 claim.


How can you remove the Coinsurance Clause

The coinsurance clause can be “suspended” for the term of the policy by adding an agreed or stated amount endorsement, or by the inclusion of a Certified Quantity Surveyors report.

This is a provision where the insurer and the insured agree to an amount of insurance and the coinsurance clause will not apply to a loss.


Coinsurance Clause Case Study

So an example of a case study of when someone has been underinsured and you’re going to have a coinsurance problem. The serial offender in these cases is usually regional pubs or hotels. What tends to happen is a be in the family for a long period of time, and the costs aren’t increased to recover the replacement costs over that time. And you have a longevity issue whether they’ve been for a long time under insurance. The other issue you’ll have there is, is that there’s a big difference between what you buy something for and what the cost of something will be to replace.

So for example, using that same case study of a regional pub, in a lot of cases, what will happen you’ll be in a small country town, and it will be quite a big pub and maybe a two storey timber pub on a corner with a big veranda, or the same scenario works well with a two or three storey brick pub as well.

The issue is that when you buy a pub for say $800,000 or $1,000,000 dollars, you may really only be buying the ground floor pub component in terms of value.

In many cases, these country towns have receded over the years. They don’t have the big workforce and transit workforce through the railways. Many of these pubs had a Chinese restaurant as an example for both takeaway food and pub food.

The commercial kitchen isn’t being used anymore, the big dining hall isn’t being used anymore and is really a large storage room.

Likewise, the second story part of the pub, which is usually accommodation and mixture of the caretakers accommodation or ‘to rent accommodation’, have not been unused for decades.

Doors are screwed shut and quite derelict. So what you’re actually buy is a ground floor pub

In many cases the owners of these pubs would note that should the pub be destroyed, they would only rebuild a ground floor pub and not worry about rebuilding the areas of the pub that are no longer used (in this instance, the restaurant and accommodation component).

However when we look at determining the replacement costs to rebuild this brick pub or timber federation pub in today’s market, we have to rebuild it with all the restaurant facilities and accommodation.

A purchase price of a $1,000,000 pub may well actually be a construction cost to build of closer to $2,500,000.

If the policy holder does not insure the pub for the replacement value, then they will be considered a coinsurer and trigger coinsurance clauses.


In this example it would look like this.


Total Loss Claim

Current Insured Value    ÷             Actual Real Value             =             Your Insured %

$800,000                      ÷                  $2,500,000               =                              32%



Amount of Loss Value    x              Insured Percentage %    =             Your Payment Value

$800,000                     x                         32%                      =                             $256,000


In this example, the policyholder would receive $256,000 (less any deductible) for a total loss.


Partial Loss Claim

Let’s assume a fire destroys part of the bar and kitchen and it will cost $78,000 to fix.


Current Insured Value    ÷             Actual Real Value             =             Your Insured %

$800,000                      ÷                $2,500,000                 =                             32%



Amount of Loss Value            x              Insured Percentage %            =             Your Payment Value

$78,000                                 x                        32%                              =                             $24,960


In this example, the policyholder would receive $24,960 (less any deductible) for repairs.

There is a disconnect between what policy holder wants to insure it for and what they should insure it for.