What is the purpose of the co-insurance clause in an insurance policy?

The purpose of the co-insurance clause in an insurance policy is to protect the insurance company when a building is underinsured. This clause essentially requires the policyholder to carry insurance coverage that is at least a specified percentage of the property's actual cash value or replacement cost. If the insured amount falls below this requirement, the policyholder may not receive full compensation in the event of a loss.

For instance, if a building is valued at $500,000 and the co-insurance clause requires that the property be insured for at least 80% of its value, the policyholder must have at least $400,000 of coverage. If they only insure it for $300,000 and suffer a loss, the amount they receive may be reduced, as the insurance company will only pay out in accordance with the actual value of the coverage relative to the required amount. This mechanism encourages property owners to maintain adequate coverage levels and serves as a way for insurance providers to mitigate their risk associated with underinsured properties.