Most property policies carry a coinsurance condition, sometimes called average. It says you must insure for at least some percentage of the full value, commonly 80 per cent, and if you do not, every claim is reduced in proportion to how short you are.
payout = loss × (sum insured ÷ (value × coinsurance %)), capped at the sum insured
Take a building worth $800,000 with an 80 per cent requirement. The required sum insured is $640,000. Insure it for $600,000 and you are covered for 93.8 per cent of what the condition asks, so every claim is paid at 93.8 per cent. The coinsurance penalty calculator works through it.
The first bite is proportional
On a $120,000 loss the penalty is $7,500. After a $2,500 excess the payout is $110,000 and the total out of pocket is $10,000. On a $20,000 kitchen fire the penalty is $1,250. On a $400,000 loss it is $25,000.
That is the part people underestimate, because the shortfall feels like something that would only matter in a catastrophe. It does not. It is charged on every claim, including the small ones that actually happen, and it is charged at the same 6.25 per cent each time.
The second bite is the ceiling
Now lose the whole building. The proportional calculation gives $750,000, but the policy will not pay more than the $600,000 you insured for. So the penalty takes $50,000 and the sum insured limit takes a further $150,000, and the total out of pocket is $202,500.
Those are two different reductions with two different causes, and it is worth separating them, because the second one does not need you to be underinsured at all. Insure the same building for exactly the required $640,000 and the coinsurance penalty disappears entirely, as it should. A total loss still leaves you $160,000 short, because 80 per cent of value was always the requirement and never the cover.
That is the sentence worth rereading. Meeting a coinsurance requirement means avoiding a penalty. It does not mean being fully insured, and a policy that satisfies the condition on the day of a total loss can still be short by a fifth of the building.
Which means the sum insured is the whole game
If the number that matters is the sum insured, then it is worth building up rather than guessing at. The rebuild cost calculator works from floor area and a build rate and then adds the parts that get left off: demolition and site clearance, professional fees, outbuildings and paving, and an allowance for cost rises during the rebuild itself, which can run a year or more after the event.
The timing point is the one that quietly breaks policies. A coinsurance condition is applied to the value at the time of the claim, not the value when the policy was written. A sum insured that satisfied the condition comfortably when it was set can fail it a few years later without anything happening at all, simply because building costs rose and the number did not.
None of this is advice about a particular policy, and the wording varies more than the arithmetic does. The figures here are a way of seeing the shape of the problem. For what a specific policy says and what your building would really cost to rebuild, a licensed insurance professional and a quantity surveyor are the people who can answer it.