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The Perils of Being Underinsured: The Coinsurance Clause Explained

In an ever-changing and accident-prone world, the importance of insurance cannot be overstated. Insurance provides a safety net against unexpected disasters, but what happens when you're underinsured and the safety net starts to fray? In this blog post, we'll explore the pitfalls of being underinsured, the role of coinsurance, and offer advice for both brokers and insureds.

Understanding the Dilemma

Perhaps the biggest myth in insurance is that you should insure your property for its market value. The reality is that you need to insure it for its replacement value (also called replacement cost), the total cost to rebuild the structure as it currently stands, including expenses associated with labor, materials, equipment, and general conditions.

Failure to insure your property for its replacement value can result in being underinsured and trigger co-insurance in the event of a claim.

What does it mean to be underinsured?

Underinsurance occurs when a policyholder's insurance coverage is insufficient to fully cover the cost of a loss or damage. It can result from inadequate coverage limits or failure to update coverage as asset values change. Being underinsured affects policyholders when a total loss occurs. If a farmer is insured for $200,000 but the cost to replace the building is $300,000, their insurance company will only pay out $200,000 for the loss. Farmers risk being unable to recover if they can not come up with the extra money required to rebuild that is not covered by their insurance.

One of the culprits behind underinsurance is inflation. Over time, the cost required to rebuild or replace damaged property can increase. If your insurance policy doesn't account for these inflationary factors, you could find yourself with insufficient coverage when disaster strikes.

Another common reason farmers end up underinsured is when they remodel their structure without informing their broker of the increased value. If structures or equipment have been upgraded, it is essential that the policy reflects these updates.

What is coinsurance?

Another common property insurance myth is that being underinsured will only impact you in the case of a total loss. In reality, carrying insurance limits that are not sufficient for the structure being insured can affect your claim payout for any size loss because of the coinsurance clause. Coinsurance clauses are included in most property insurance contracts.

A coinsurance clause requires the policyholder to share a certain percentage of the covered losses. Typically expressed as a percentage, it represents the portion of the loss that the policyholder is responsible for after the deductible has been met. Most policies require an insured amount equal to 80% or more of the replacement cost. ARU requires coinsurance limits of 90%. Failure to meet this requirement can have serious consequences.

For this example, let’s say that a portion of a building (insured at $200,000 but costs $300,000 to rebuild) was destroyed and the policy has a 90/10 coinsurance clause. Since the property is underinsured according to the coinsurance clause, their claim payment may be reduced at the time of loss. Essentially, it will be reduced in proportion to the coverage deficiency. This is a harsh reality that many policyholders aren't aware of until it's too late.

How to avoid being underinsured?

Before 2019, it was common practice to conduct yearly assessments of insurance coverage limits. Values have become more volatile in the years since, so we recommend brokers and insureds conduct semi-annual checks to ensure that they can get their operations up and running once again if a significant loss occurs.

For brokers, it's crucial to be proactive in ensuring your clients have adequate coverage. If a client is unwilling to insure for the full replacement cost, we recommend having them sign an agreement acknowledging the potential consequences of underinsurance to protect you against potential liability.

On the insured side, it's essential to do your own due diligence. Ask contractors for estimates on replacement costs as they come out to your property to make repairs in order to get a better idea of what you need to be insured for. You shouldn't rely solely on your broker; you must take an active role in understanding your policy.

When it comes to insurance, everyone wants to save money but the perils of being underinsured should never be underestimated. Co-insurance clauses are a standard part of most policies and being unaware of their implications can lead to financial hardship. Brokers and insureds must work together to ensure that policies reflect the true replacement cost, thereby mitigating the risks associated with underinsurance. To safeguard your financial well-being, educate yourself and seek expert advice when navigating the complex world of insurance.

At Agribusiness Risk Underwriters, we’re here to be a guiding light for farm / ag professionals. We understand the unique challenges that farmers and agribusiness owners face, and we specialize in tailoring insurance solutions to ensure they’re adequately covered for replacement costs and inflationary factors.

Our commitment to navigating the complex landscape of agribusiness insurance goes beyond just selling policies; we're experts in risk management. Don't leave the future of your client’s agricultural endeavors to chance—partner with Agribusiness Risk Underwriters, where expertise and dedication meet to protect what matters most.

Agribusiness Risk Underwriters specializes in delivering farm and agribusiness insurance solutions to “hard-to-place” accounts such as livestock confinement, cotton gins, agricultural processing, cold storage, wineries, warehouses, and more. Learn more about our poultry insurance products - Poultry Express and Poultry Plus. For a reliable farm / ag property market with up to $25 million per occurrence limits, discover Flex.


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