In The Nick of Time: The Risk of Underinsurance

Written by Nick Chapekis CIC, CRM

What exactly is underinsurance?  Basically, it’s possessing insurance coverage that won’t pay out enough to cover the full expenses incurred as the result of a loss.  This is not an issue with automobile insurance policies, as claims are generally settled on a market value basis.  However, with homeowners’ insurance, claims are settled based on limits enumerated within each policy.  If the limits aren’t high enough, there could be a significant gap between what it costs to repair or rebuild a home and how much the insurance company is obligated to cover.

To determine this limit, insurance companies require “insurance-to-value”, which is generally calculated by agents using software-based replacement cost estimators, or by an actual on-site inspector.  Keep in mind this value is not based on market value, but rather the actual cost to repair or rebuild.  Unfortunately, replacement values are fluid and affected by market forces beyond anyone’s control.  Among these are availability and cost of labor, which could be impacted in the event of a large-scale event (such as a tornado), and availability and cost of materials.  Both are significant issues currently: in 2021, weather disasters cost $148 billion, while the cost of lumber increased 21.8%, the cost of asphalt roof tile increased by 21.5%, household furnishings rose 10.6%, and construction job openings have increased 4.9%.

To protect consumers from becoming underinsured, most insurance companies have inflation protection built into their policies, usually increasing coverage by 4% automatically at renewal.  Some also have endorsements available which afford coverage at either 120%, 125%, or 150%, of the limit shown in the policy declarations.  And with some high-end policies, full guaranteed replacement value is included.  However, there are many policies that have none of these protections, which could leave policyholders exposed to significant financial losses.  So, make sure to check with your insurance agent about what protections, if any, you have on your policy, and whether it makes sense to review your coverage limits.