How is a coinsurance penalty calculated on an apartment insurance claim?

The coinsurance penalty formula in the ISO Commercial Property Conditions (CP 00 90) divides the amount of insurance you carry by the amount you should carry (replacement cost multiplied by the coinsurance percentage), then multiplies the result by the covered loss, minus the deductible. If the ratio is less than 1.0, you receive less than the full covered loss.

Worked example: An apartment building has a replacement cost of $8,000,000. The policy has an 80% coinsurance clause and the owner carries $5,000,000 in coverage. A fire causes $400,000 in damage with a $10,000 deductible. The required insurance is $6,400,000 (80% of $8,000,000). The payout calculation is: ($5,000,000 / $6,400,000) x ($400,000 - $10,000) = 0.78125 x $390,000 = $304,688. The owner absorbs the remaining $85,312 plus the $10,000 deductible, for a total out-of-pocket cost of $95,312 on a $400,000 loss.

The Fannie Mae Multifamily Selling and Servicing Guide addresses this risk by requiring either no coinsurance clause or an agreed amount endorsement that suspends coinsurance entirely. Freddie Mac's Seller/Servicer Guide similarly requires a coinsurance clause of no less than 90% or an agreed amount endorsement. Apartment owners can avoid the penalty altogether by obtaining an agreed amount endorsement and submitting an accurate statement of values, or by insuring to 100% of replacement cost. Annual replacement cost appraisals, especially during periods of construction cost inflation, are essential for maintaining adequate coverage levels.