Calculate Deductibles, Limits and Coinsurance

Introduction

When a covered loss happens, what the insurer pays may differ from the covered repair bill. It starts with the loss amount and then applies a few rules written into the policy. This lesson covers the three most common ones:

• Deductible: the part of the loss you pay yourself.
• Limit: the most the insurer will pay.
• Coinsurance: a requirement to carry enough insurance. If you carry too little, your payment is reduced.

Each rule answers a different question. If you keep those questions separate, the arithmetic stays simple.

By the end of this lesson, you should be able to:

• Tell apart the property's value, the limit of insurance and the covered loss amount.
• Subtract a fixed-dollar deductible from a covered loss, including when the loss is smaller than the deductible.
• Turn a percentage deductible into dollars when its base is stated.
• Apply a limit as a ceiling on payment, in the order a problem or policy states.
• Find the amount of insurance a coinsurance clause requires, and calculate a reduced payment when the insurance carried falls short.

Before you start: you should already know how a covered loss is valued. That is covered in how to value damaged property correctly. Here, the covered loss amount is always given to you.

One important ground rule: every percentage, base, limit and order of steps in this lesson comes from a fictional policy or an exam-style question. These are not universal rules and not legal requirements. Real policies differ, so always use the numbers and the order you are given.

Three numbers that are easy to mix up

Before calculating anything, sort the dollar amounts in the problem. Three of them sound alike but answer different questions.

• Value of the property: what the whole property is worth. How much is the building worth?
• Limit of insurance: the amount of insurance bought, which is the most the insurer will pay for that coverage. Problems may also call it the amount of insurance carried. How much insurance was bought?
• Covered loss amount: the valued damage caused by a covered event. How much damage did this event cause?

Example. Desert Tile Supply owns a warehouse worth $500,000. It carries a $400,000 building limit. A covered fire causes $30,000 of damage.

• The $500,000 value describes the whole warehouse.
• The $400,000 limit is a ceiling on payment.
• The $30,000 loss is the starting point for this claim.

The insurer does not owe $500,000 or $400,000 just because a loss happened. The calculation starts from the $30,000.

Step 1: The deductible

Plain meaning: a deductible is the part of a covered loss that you pay yourself. The insurer subtracts it from the amount it would otherwise pay.

A fixed-dollar deductible

Example. Juniper Café has a $1,000 deductible. A covered pipe burst causes $7,400 of damage.

• Payment = $7,400 − $1,000 = $6,400

The deductible reduces the payment, not the damage. The café still has $7,400 of damage. It covers $1,000 itself, and the insurer pays the rest.

Change one fact. Suppose the covered damage is only $800, with the same $1,000 deductible.

Subtraction gives −$200, but an insurer does not bill you for having a small loss. The payment cannot go below zero, so the insurer pays $0. The café's whole $800 loss sits inside its deductible.

Tempting mistake: subtracting the deductible from the limit or from the property's value. The deductible comes off the loss amount.

A percentage deductible

Some deductibles are stated as a percentage. A percentage means nothing until you know what it is a percentage of. That "of" amount is called the base.

Example (fictional policy terms). A policy states a 2% deductible, based on the building's limit of insurance. The limit is $250,000.

• Deductible = 0.02 × $250,000 = $5,000
• Covered loss of $18,000 → payment = $18,000 − $5,000 = $13,000

Change one fact: the base. Suppose a different fictional policy says the 2% is based on the building's value, and the building is worth $300,000.

• Deductible = 0.02 × $300,000 = $6,000
• Payment = $18,000 − $6,000 = $12,000

The percentage was the same in both cases. The base changed, so the deductible changed. Always find the stated base before you multiply.

Check yourself

1. A covered loss is $3,300. The deductible is $2,500. What does the insurer pay?
2. A question says only "4% deductible" and gives a building value, a limit and a loss amount. What should you do before calculating?

Step 2: The limit

Plain meaning: the limit of insurance is a ceiling on what the insurer will pay. It is not a promise to pay that amount.

In this lesson, follow the order shown in a standard sample builders risk form:

1. Subtract the deductible from the loss.
2. Compare the result with the limit.
3. The insurer pays whichever amount is lower.

When the loss stays under the limit

Example. Red Rock Printing has a $150,000 limit and a $2,500 deductible. Covered damage is $40,000.

• $40,000 − $2,500 = $37,500
• $37,500 is below $150,000, so the insurer pays $37,500

A high limit does not raise the payment. The ceiling only matters when you reach it.

When the loss goes past the limit

Change one fact. Covered damage is now $190,000.

• $190,000 − $2,500 = $187,500
• $187,500 is above the $150,000 ceiling, so the insurer pays $150,000

The remaining $40,000 is not paid under this coverage.

Why the order of steps matters

Now try a loss of $151,000, which is just over the limit.

• $151,000 − $2,500 = $148,500
• $148,500 is below $150,000, so the insurer pays $148,500

Under this order, the full limit is paid only when the loss is at least the limit plus the deductible. Here, that is $150,000 + $2,500 = $152,500.

Tempting mistake: subtracting the deductible from the limit. For the $190,000 loss, that gives $150,000 − $2,500 = $147,500. That is wrong under the order used here.

If a question or policy states a different order, such as "apply the limit first, then subtract the deductible," then $147,500 would be correct for that question. Do not assume one order is universal. Read which order is stated.

Check yourself

A policy has a $50,000 limit and a $1,000 deductible. Use this lesson's order.

1. Covered loss is $50,600. What is paid?
2. Covered loss is $58,000. What is paid?

Step 3: Carrying enough insurance for the property's value (coinsurance)

Plain meaning: some property policies include a coinsurance clause. It requires you to buy insurance equal to at least a stated percentage of the property's value. If you buy that much, there is no coinsurance reduction. If you buy less, the insurer pays only part of the loss, in proportion to how far short you fell. The clause protects the insurer against customers who underinsure.

The name can mislead you. "Coinsurance" here does not mean you always share every loss. You absorb an extra share only when the insurance you carry falls short of the requirement.

The three steps

1. Required insurance = value of the property × coinsurance percentage
2. Was the requirement met? Compare the limit carried with the required amount.
3. Calculate the payment: - If the requirement was met: loss − deductible, then apply the limit. - If it was not met: loss × (carried ÷ required), then subtract the deductible, then apply the limit.

The policy also says when the value is measured. One insurer's guide uses the value at the time of the loss. The sample builders risk form uses the building's value on its completion date. In exam problems, use the value you are given.

Worked example: enough insurance

Mesa Flooring's building is worth $600,000. The policy has an 80% coinsurance clause, a $1,000 deductible and a $500,000 limit. Covered damage is $60,000.

1. Required = $600,000 × 0.80 = $480,000
2. $500,000 carried is at least $480,000, so the requirement is met. No coinsurance reduction applies.
3. $60,000 − $1,000 = $59,000. This is under the limit, so the insurer pays $59,000.

Meeting the requirement removes the coinsurance reduction, nothing more. The deductible, the limit and the policy's other terms still apply.

Change one fact: too little insurance

Keep everything the same, but Mesa Flooring carries only a $360,000 limit.

1. Required is still $480,000.
2. $360,000 is less than $480,000, so the requirement is not met.
3. Ratio = carried ÷ required = $360,000 ÷ $480,000 = 0.75. Mesa Flooring carried three-quarters of the required insurance.
4. Adjusted loss = $60,000 × 0.75 = $45,000
5. Subtract the deductible: $45,000 − $1,000 = $44,000
6. Check the limit: $44,000 is under $360,000. The insurer pays $44,000.

Mesa Flooring absorbs $60,000 − $44,000 = $16,000. That is the $1,000 deductible plus a $15,000 coinsurance reduction.

Three tempting mistakes

• Dividing by the value instead of the requirement. $360,000 ÷ $600,000 = 0.60 gives $36,000 − $1,000 = $35,000. That is wrong because the policy asked for 80% of value, not 100%. The bottom of the ratio is the required amount.
• Subtracting the deductible first. ($60,000 − $1,000) × 0.75 = $44,250. The method used here applies the ratio to the loss first, then subtracts the deductible.
• Multiplying the percentage by the loss. The coinsurance percentage applies to the property's value. It tells you how much insurance was required. It is not a share of the damage.

The limit still applies after coinsurance

The ceiling still matters when a large loss meets a coinsurance reduction.

Example. A building is worth $500,000. The policy has 80% coinsurance, a $300,000 limit and a $2,000 deductible. Covered damage is $480,000.

1. Required = $400,000. Ratio = $300,000 ÷ $400,000 = 0.75.
2. $480,000 × 0.75 = $360,000
3. $360,000 − $2,000 = $358,000
4. The limit is $300,000, so the insurer pays $300,000.

The full order used in this lesson

1. Start with the covered loss amount.
2. Coinsurance: if a clause applies and the requirement is not met, multiply the loss by carried ÷ required.
3. Deductible: subtract it, and never go below $0.
4. Limit: pay the lower of the result and the limit.

This order matches the sample builders risk form and the insurer's coinsurance guide listed in the sources. If a question or policy states a different order, follow the stated order.

How the neighboring terms differ:

• The deductible answers: how much of this loss do you keep?
• The limit answers: what is the most the insurer will pay?
• Coinsurance answers: did you buy enough insurance compared with the property's value?

These are three separate checks on the same claim. They are not three types of policy.

Check yourself

A building is worth $800,000 under an 80% coinsurance clause. The owner carries a $600,000 limit. Is the requirement met? If not, what ratio would you apply to a loss?

Practice on your own

Use the order from this lesson unless a problem says otherwise. All policies and amounts are fictional.

1. A homeowner's policy states a deductible of 1% of the dwelling's limit of insurance. The dwelling limit is $320,000. (a) Covered damage is $9,750. What is paid? (b) Covered damage is $2,900. What is paid?

2. A shop building is worth $140,000. It has an $85,000 limit, a $1,500 deductible and no coinsurance clause. (a) Covered damage is $86,000. What is paid? (b) Covered damage is $97,000. What is paid?

3. A building is worth $250,000 under a 90% coinsurance clause. The owner carries a $180,000 limit and has a $500 deductible. Covered damage is $35,000. What is paid?

4. Same building as Problem 3, but the owner raised the limit to $230,000 before the loss. What is paid for the same $35,000 of damage?

5. A year later, the building's value at the time of a new loss is $300,000. The limit is still $230,000, and the 90% clause is unchanged. Is the coinsurance requirement met?

What to remember

• Sort the numbers first. Value is what the property is worth, the limit is the most the insurer pays, and the loss is the damage from this event.
• A deductible comes off the loss, never below $0. A percentage deductible needs its stated base before you can calculate it.
• A limit is a ceiling. Under the order used here, subtract the deductible from the loss, then pay the lower of that result and the limit.
• Coinsurance: required = value × percentage. If the limit carried is enough, there is no reduction. If it is short, multiply the loss by carried ÷ required, then subtract the deductible, then apply the limit.
• Use the percentages, bases and order of steps the policy or question gives you.

You will combine these steps with other topics in solving mixed cases and repairing weak spots.