In March of this year, a fire broke out at a Dallas, TX home while the owners were hosting a party.  A fire in their outdoor fireplace quickly spread to the roof.  The hosts rushed to get the family and guests out safely, including two grandchildren, who were upstairs watching tv, and their dog. The fire department arrived within several minutes, but the home was ultimately a total loss.

Gratefully, there were no injuries or loss of life.  However, the owners would unfortunately learn that their home was severely underinsured.  The dwelling coverage limit on their homeowner’s policy, at the time of the fire, was $723,000.  Ultimately, the cost to rebuild the property to the original condition was upwards of $1,400,000 – leaving the owners with an out-of-pocket expense of more than $600,000.

These homeowners are not alone.  In a staggering statistic, approximately 2 out of every 3 homes in the U.S. are underinsured. On average these homes are underinsured by 22%, but some homes can see underinsurance amounts higher than 60%.

What does it mean to be underinsured? It means that the amount of insurance coverage received is less than the value it would take to rebuild the home. While this might mean that homeowners can enjoy lower monthly premiums, the consequences can be life-altering in the event of a natural disaster or total loss scenario.  

Nowhere has this been more apparent than in the wake of several large wildfires over the last decade. Almost 80% of homes that were affected by the 2018 California wildfires were underinsured, with 60% of those homes being severely underinsured.

More recently, the surprise Marshall Fire in the closing days of 2021 led to 951 total loss claims where up to 67% of homes were underinsured. The Colorado Division of Insurance estimated that this quick, two-day blaze saw an underinsurance gap of up to $155 million.

This is not a problem related to just the coasts.  Tornado alley is also looking at a potential shortfall in insurance coverage. In Oklahoma alone, which averages about 56 tornadoes per year, about 1.3 million properties with $257 billion in reconstruction costs are at very high or extreme risk. If insurance on these homes is not valued at current cost levels, which have increased 6.6% over the past two years, homeowners could be left with huge losses. If one tornado caused 20% damage to just 1% of the homes deemed at very high risk, the reconstruction coverage would fall short by approximately $34 million.

And, underinsurance is not just a factor when it comes to a “total” loss of a property.  Many homeowner’s insurance policies include a coinsurance provision – which will decrease the amount of claim payment at the time of loss if coverage is not maintained to at least 80% of the total cost to rebuild.  Even a partial loss can be financially devastating in that case.

Home renovations and improvements add an additional layer of complexity.  Homeowners may not remember to tell their insurance advisor about substantial improvements, or adding square footage at a property.  It is imperative to convey this information so coverage may be adjusted.  Further, some homeowner insurance contracts restrict coverage, or impose very high deductibles, if there is a claim during renovation time and the carrier was not made aware of the work.

How did we get here?  Underinsurance has been a problem plaguing the insurance space for decades but is even more acute in the current day.  Government lockdowns during the pandemic halted production of critical goods, which later resulted in a shortage when demand for these goods climbed sharply.

Reconstruction costs tend to increase 2-4% annually, relatively in line with inflation, but the shortage of both labor and materials has led to increases as large as 20-30% between April 2022 and April 2023.  Additionally, as natural catastrophes continue to increase in both frequency and severity, increased demand for labor and materials after an event creates a phenomenon known as demand surge.

Underinsurance is caused by both technological and human factors. On the technology side, the coverage software used by carriers can misinterpret unstandardized and disparate public data sources to produce inaccurate data that provides a shaky foundation for the rest of the process.

Software shortcuts and the reliance on only a few basic informational questions to deploy coverage also lay the groundwork for widespread underinsurance. Automated processes may also rely on customer-input information, which can often be inaccurate.

Human factors are also contributing to the problem, where larger macro issues are at play. Because coverage is often compared solely by the price of the premium, some brokers are pressured to streamline the new quoting process and not raise issues that might lose customers in a competitive marketplace where an attractive premium is king.

This means that in the quest to provide a competitive quote and acquire a customer, accurate coverage amounts become a secondary consideration. This same force is also in play when it comes to renewals, where insurers are pressured to keep premiums, and therefore coverage amounts, low to retain a policyholder in an easily shoppable market.

But as consumers become increasingly aware of the underinsurance issue, the carriers and brokers that do right by the homeowner and provide sound advice will win out over the carriers that build a reputation for stranding customers in the event of a catastrophic loss.

What can homeowners do?  It is critical to work with brokers and insurance carriers that have a deep knowledge and understanding of how to accurately value homes and physical property.  This is particularly true for large, well-appointed homes with complex systems and highly unique finishings.  An annual review of insurance coverage will ensure adequate limits are maintained and updated if needed.

Seeking out homeowner’s policies with guaranteed replacement cost and automatic inflation guard provisions can alleviate potential underinsurance issues.  Guaranteed replacement cost coverage will pay the ultimate cost to rebuild a home, regardless of the limit shown on the policy.  And inflation guard will adjust the dwelling coverage limit annually to account for current reconstruction costs.

Carriers in the high-net-worth segment, including Chubb, AIG Private Client Group, and Cincinnati Insurance – feature these coverages in most of their insurance contracts.

Accurate insurance-to-value is a challenge the insurance industry will never rid itself of.  In the current environment, it is crucial to seek out informed advice from a risk management professional.


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