Is Underinsurance a Problem?

Over the years we’ve talked to thousands of people who have lost their homes to natural disasters. We have found that over 90% of the people we talk to are grossly underinsured.

Insurance companies are able to determine exact dwelling coverage amounts with sophisticated computer programs that they pay a lot of money for. One company called Marshall & Swift, who makes such software, claims “...more than 70 years of experience [with] over 100,000 individual users, including underwriters, claims adjusters, inspectors, and agents.”

Within days, if not hours, following a wildfire, adjusters, agents and insurance contractors inform dazed fire victims, “You are underinsured!” Usually, this is the first time the homeowner has even considered that they might be underinsured.

Through interviews, we’ve found that only 8% of the people we’ve talked to who lost their houses in the 2007 wildfires were insured to at least 80% of their loss. Only 2% were insured to 90% of their loss. On average, their dwellings were only covered for 55% of their replacement value.

Also, even though insurance companies new that reconstruction costs exceeded $200/SF after the 2003 wildfires, 85% of the people interviewed were insured at less than $200/SF.

Why do Companies Underinsure?

It’s hard to imagine why insurance companies would give up additional premiums by underinsuring customers, but we find they do it every day. We can only give educated guesses on why they would do it, but here are some ideas we've come up with.

To limit their overall exposure and risk. The premium collected for the increase in coverage might not be worth the small increase in income. Selling this coverage to everyone would increase the amount of exposure to the company without the same degree of increase in premium.
Total Losses are rare. Most losses (99 percent) are small, partial losses, so why insure for the 1 percent of total losses?
To compete in the marketplace. Everyone else does it and no one wants to be the first to charge more.
To keep you paying the annual premium payment. If they raise your premium, you’re likely to shop elsewhere.
To shift the risk to the homeowner. If they don’t sell that additional coverage, it's very difficult for a claimant to recover that additional amount after a total loss.
To reduce their re-insurance expenses. If they sell you more coverage, they have to buy more re-insurance coverage.

How do Companies Underinsure?

When you call to buy your policy, companies typically use a construction cost and dwelling evaluation computer program like Marshall & Swift’s "Residential Component Technology." The computer programs are sophisticated and have been “perfected” over many years.

In our experience, if ALL parameters are input, an accurate replacement cost (Coverage A limit) for your dwelling can easily be determined. This process usually takes about 15 minutes, but unfortunately the agents can use built-in shortcuts which can lead to underestimating the rebuild value.

These are the minimum required fields in the software to determine a coverage amount:

Zip Code
Building Type (related to occupancy)
Stories
Square Footage
Construction Type

Do these questions sound familiar? When you've called an insurance agency or company to get a quote, are these the only questions they've asked? If so, you should call them back and do a review to make sure you're fully insured.

What You Can Do To Protect Your Home

By now you’re wondering, “What can I do to protect myself?” Here are a few tips to get you on your way to being fully insured.

Look for a company who offers Guaranteed Replacement. These companies are far and few between and are very picky about who they cover, but they do exist.
Go to a competitor for a FULL quote. See what other companies are offering. Tell them you want to be fully covered in case of a total loss.
Have your insurance agent help you calculate the costs of rebuilding your home. They are the experts and deal with this every day. Rely on their expertise.
Insist on TOTAL home replacement. Voice your concerns and wishes. Do not let it go unsaid. Have them give you their promises in writing.
Insist on INFLATION GUARD. This will annually increase the amount of coverage you have by an inflationary calculation.
Insist on PERSONAL PROPERTY floaters. If you have specialty items or an extra-ordinary amount of personal property, make sure they are covered.
Insist on being told ALL products available. Ask if they have any additional products they could sell you as add-on’s to your homeowner’s policy. For example, some companies offer higher percentages for extended replacement, code upgrade, personal property and/or appurtenant structure coverage.
Be aware of coverage for appurtenant or “other structures”. If you have a detached garage, guest house, large retaining walls, long walkways, large sheds etc., you might be in need of additional coverage for these structures.
Increase the deductible to reduce the premium. If increasing your coverage is tightening your budget, get a discount by increasing your deductible. If you have a high deductible they know you won’t be turning to them for small “nuisance” claims.
After reviewing your coverage, write a letter of thanks. Nothing is more frustrating than knowing you asked for more coverage and not being able to prove it later. Write a letter of thanks to your agent for reviewing your coverage to make sure you are fully covered. CC the home office to tell them how pleased you are about the agent taking the time to make sure you're fully insured.

Results of Underinsurance

The economic result of realizing you're underinsured following a disaster can be devastating. If you are insured for $200,000 and find out you lost $350,000 in property, it will be very difficult to recoup that uninsured loss. Do what you can now to make sure you're properly insured.