John Smith owns a commercial building valued at $800,000. To save on insurance premiums, he insures the building for only $600,000. When Smith's building suffers $600,000 worth of damage in a fire, he is confident that the loss will be fully covered.
However, he is sadly mistaken because his insurance policy contains an 80 percent co-insurance clause. The amount Smith receives will equal the amount of the insurance divided by the co-insurance percentage multiplied by the value of the property and then multiplied by the amount of the loss.
insurance amount/(co-insurance % * value of property)*amount of loss
In this example, $600,000 / (80 percent x $800,000 = $640,000) = 0.9375. Then, 0.9375 x $600,000 = $562,500.
Smith is a co-insurer (along with the insurance company) for the loss. Specifically, Smith's share of the loss is $37,500 ($600,000 less $562,500).
Note that there will be a full recovery (subject to the policy limit, of course), if the amount of the insurance is equal to, or higher than, the value of the property multiplied by the co-insurance percentage. Thus, in this example, Smith would have received a full recovery for his loss ($600,000), had he insured the building for at least 80 percent of its fair market value ($800,000 x 80% = $640,000).
In general, when there is a co-insurance clause, the insured will recover the lowest of the policy limit, the value of the loss or the amount derived from the co-insurance calculation.