Homeowners insurance policies typically have a coinsurance clause that requires you to carry coverage worth a certain percentage of your home’s value. Failure to meet the requirement reduces your compensation after a loss.

What policies have coinsurance clauses?

Almost all property insurance policies – including homeowners insurance – includes a coinsurance clause. By requiring property owners to carry coverage at least equal to some percentage of a property’s total value, coinsurance clauses help to fairly distribute risk between policyholders and insurance companies.

The amount of coverage required by a coinsurance clause can vary by provider or policy, but typically ranges from 80% to 100%. If a property owner doesn't carry coverage equal to or greater than the amount required by their coinsurance clause, then their coinsurance has not been satisfied.

How does coinsurance work?

Coinsurance clauses are a feature of almost all home insurance policies to encourage policyholders to carry an appropriate amount of coverage. The clause does this by requiring you to insure your home for a percentage of your home’s actual cash value or its replacement cost. Basically, the coinsurance clause prevents you from underinsuring your home.

If you don’t insure your property at the specified percentage, typically at least 80% of its value, you can face a coinsurance penalty.

What is a coinsurance penalty?

A coinsurance penalty is the amount you may have to pay for a loss if you do not insure your home for the amount required in your policy’s coinsurance clause. Your insurer still covers your loss but only for a percentage of what you might expect.

An example of when coinsurance is satisfied

Let’s say your home’s replacement cost value is $200,000, and your coinsurance requirement is 80%. You need to insure your home for at least $160,000 to avoid the penalty.

Please note: Insuring your home for $160,000 satisfies the coinsurance clause, but it may leave you short when you need to replace your property. Even though your replacement cost is $200,000, the most your insurance provider might pay is $160,000 for a total loss. And that doesn’t take your deductible into consideration.

An example of when coinsurance isn’t satisfied

But now let’s say you want to save money and decide to insure your $200,000 home for only $100,000. When you file a claim, your insurer will realize your coverage falls short of the requirement and use a formula to determine your penalty. The penalty amount is deducted from your claim settlement.

The same is true if you choose to insure your home for its actual cash value and fail to secure sufficient coverage. But in that case, your insurance provider also deducts your property’s depreciation from your reimbursement.

Factors that affect coinsurance amounts

Perhaps the trickiest part of the coinsurance clause is the valuation. Your home’s value can change due to inflation and home improvements, like:

• Finishing your basement.

• Upgrading your electrical.

• Replacing your windows.

• Landscaping your yard.

A change in your home’s value can mean you fall short of the coinsurance clause requirements. On the other hand, depreciation may mean you’re paying too much for your insurance, so be sure to get your home appraised semi-regularly.

How can I avoid a coinsurance penalty?

A coinsurance penalty can be an unpleasant surprise when you’re trying to recover from a loss. However, you can avoid it. Here’s how:

• Find out what your coinsurance clause is. You can usually find this information in the “conditions” section of your policy under the heading Loss Settlement.

• Determine the value of your house on a regular basis. Get an appraisal once every three years.

• Set your insurance limits appropriately. Take the information you’ve gathered and review it with an agent. They can help you fulfill the coinsurance clause requirement.

Staying on top of your policy is an important part of owning a home. Check out our blog for more tips on getting the most out of your home insurance.