Underinsurance Crisis Overview

A majority of policyholders find out too late that their policy limits were undervalued and are left on their own to rebuild substantial portions of their homes out-of-pocket because insurers are actually incentivized by a number of counterintuitive factors to provide inadequate coverage.  The problem arises because insurers often use misleading terms to describe their policies and everyday consumers reasonably expect that insurance companies want to sell more insurance to both generate more revenue and protect their customers. Oftentimes, however, market forces counter intuitively pressure insurance carriers to sell premiums at a lower price and quantity in order to maximize profits by decreasing their investment in risk.

Perhaps the best way homeowners can avoid the unfortunate complications of underinsurance is to properly inform themselves at the time of purchase and renewal.  This resource guide explains some of the common underinsurance pitfalls, including (1) an overview, (2) coverage and policy issues, and (3) the agent or broker relationship.  The links immediately below provide an overview and outline general practices to help consumers avoid the underinsurance problem before disaster occurs.

Coverage, Exclusions, Policy Limits, Deductibles, and Replacement Value Issues

Policy coverage is the amount of liability an insurer is obligated to indemnify.  However, insurance providers often place limits on the amount they will cover or exclude certain types of damages.  Although many homeowners may have a decent idea of the market value of their homes, most homeowners have little understanding of what it would cost to rebuild their homes.  Because most insurance companies place policy limits at the market value of the policyholder's home rather than the price to rebuild it and meet current building codes, homeowners often find themselves underinsured in the case of disaster, especially if there is a surge in local demand in the area to reconstruct due to an area-wide disaster.  Additionally, to offer more competitive premiums, insurers often offer policies that exclude coverage or have high deductibles that put consumers at risk.

Because most homeowners policies exclude flood and earthquake damage, they are separate issues.  Please see our guide on fixing flood insurance and earthquake insurance guide for further assistance.  See below for some useful resources to help determine whether your coverage and policy limits are adequate.

Insurance Agent and Broker Relationship

Oftentimes, an agent or broker is a homeowner's only contact with the insurer.   The homeowner commonly has little to no involvement in setting the policy and relies on the agent or broker to set adequate limits.  Nonetheless, absent a special relationship, insurers and the courts often hold insureds solely responsible for establishing their policy limits.  Thus, it is extremely important for homeowners to work with brokers and agents they can trust to find a policy suitable for their needs.  The below links contain some of the information consumers should keep in mind while searching for knowledgeable and accommodating brokers or agents.