To Undervalue Is to Co-Insure

Paul Beaton, CIP - Senior UnderwriterContinental Casualty Company (a CNA company)

Items insured on CargoCover should always be insured to full value to protect the insured from having to bear a proportion of a loss. Co-insurance is the name of the insurance principle that obliges an insured to bear part of the cost of a loss if they underinsure an item.

Why does this principle exist? There are two major reasons for this principle. One reason is fair treatment of all insurance customers. We can illustrate this with the following example:

If Insured A purchases $50,000 coverage on a shipment that is actually worth $200,000, and Insured B purchases $200,000 of coverage on a similar item also valued at $200,000, then, assuming the rate is the same, Insured B is paying more premium than Insured A. How does this work?

Insured A pays $100 ($50,000 x 0.20 percent rate = $100)
Insured B pays $400($200,000 x 0.20 percent rate = $400)

So Insured B is paying $300 more premium than Insured A. Obviously, if the article was a total loss, Insured A would only receive the policy limit of $50,000, therefore would have either self-insured, or absorbed the $150,000 shortfall in valuation. But what if the loss is only partial? Let's say they both suffer a $10,000 loss.

Without the principle of co-insurance, the two Insureds would both receive the same $10,000 payment if they suffered a $10,000 loss. This is unfair to Insured B, who paid more but received the same benefit as Insured A.

However, under co-insurance, Insured A is paid a proportion of the loss that is equal to the proportion of the total value that he insured. In other words, if Insured A only insured ¼ of the value of the item, then he is only paid ¼ of the value of the loss. In this case, that would be $2,500 instead of $10,000. In effect then, this co-insurance requirement would mean that, although Insured A would be paying ¼ of the premium that Insured B paid, he would also be receiving only ¼ of the claim amount that Insured B received. This puts Insured A proportionally in the same position as Insured B.

But, you may ask, if co-insurance is simply about eliminating unfairness between insureds, why don't all insureds underinsure and therefore eliminate the injustice of one paying more for the same coverage? Essentially, the answer is that this practice would not provide enough premium to insurers in order to pay out all claims. This is a second major reason for co-insurance.

If everyone insured only 25 percent of the true value of their shipment, but expected to be paid as if they had insured the total value, then insurers would be receiving only a portion of the premium that they need in order to pay the full value of the losses. If this were the case, insurers would not have sufficient premium to stay in business or would need to increase rating accordingly.

To use a comparison from the transport industry, it would be similar to a common carrier being paid freight on a $2 per lb. basis by all their customers while being expected by those same customers to reimburse them on a full value basis if the carrier is liable for a loss. Although it looks like this would be a good deal for the customers, few carriers could afford this increased liability at limited liability pricing.

Similarly, the practice of underinsuring can have a detrimental effect on insureds who need the services of stable insurers with resources capable of providing efficient service and timely claim payments.

By insuring to full value, you are helping to keep cargo insurance rates competitive, ensuring that your customers are not inadvertently sharing in a claim and ensuring that there is adequate coverage in the event of a total loss.

So, to protect your interests and those of your customers, please always insure to the full value of the item being shipped.

Disclaimer:This article makes references to the CargoCover insurance policy. If you have any questions or would like to obtain copies of the policy, please contact Marsh, for details