Nearly two out of every three American homes, or 59 percent, are underinsured as homeowners, on average, have only enough insurance to pay for 78 percent of costs to replace or rebuild their homes. This is according to Marshall & Swift/Boeckh LLC (MSB), a leading provider of building replacement cost data.
With the median value of an existing single family home across the nation of about $227,500, a homeowner with a typical shortfall in coverage is at risk to pay an additional $30,000 to $50,000, or more, towards the actual cost to rebuild their home that their insurance does not cover.
This underinsurance problem was a hard lesson learned by homeowners such as those in the Gulf region who were affected by last year's hurricanes. Many of those homeowners found out that their cost of rebuilding outstripped the benefits provided by their homeowners insurance.
How Does Underinsurance Happen?
One concern in the insurance industry is that many homeowners do not update or periodically increase the coverage on their homes. When homeowners remodel and improve their homes, they often fail to follow through with a call to their insurance agent to update their coverage.
Another contributor is the surging price of building materials, energy and labor, all which have increased replacement costs up by over 7 percent a year since 2001.
But in an industry that prides itself on customer service and providing peace-of-mind to its customers, why would property insurance companies and their agents knowingly allow their customers to underinsure their homes?
After all, buying the right amount and the right type of insurance means larger insurance policy premiums, and profits for the insurance companies.
Consumer advocates say that the problem lies in the way that homeowners insurance is sold. In the competitive marketplace, the last thing an agent wants is for the customer to run down the street to a competitor because they got a quote for $50 a year less.
They say many agents provide quick quotes to close a sale, lack the training to properly asses the value of the homes they insure and often rely on over-the-phone interviews to estimate the amount of coverage for a customer's home. The result being that homeowners buy cheaply priced coverage that they mistakenly believe will replace their home in the event of a full loss.
To be fair, many homeowners have made home improvements. These improvements will increase the home's replacement value, and the dwelling limits in the homeowner's insurance policy should be increased accordingly.
Finally, not only have home values gone up, the price of materials and labor has also increased. Homes lost in disaster areas typically have to be rebuilt to conform to new building codes, to protect against wind damage or earthquakes for example, adding to the costs to rebuild the home.
Clearly the homeowner bears the responsibility to select the proper policy coverage limits, a position that is supported by laws in many states. However, if you are advised by your insurance company, agent or broker that your coverage and its underlying limits are enough to fully pay for the cost to replace or rebuild your home, then the insurance company or agent has assumed a special duty of care. If later your loss is not covered by the insurance, you may have a claim against them.
Today, most standard homeowner's insurance policies no longer provide "guaranteed replacement cost" coverage — a provision in policies that had provided homeowners peace of mind that their home would be replaced regardless of the coverage limits in their policies.
Insurance companies have included a "notice of change of coverage" in the annual policy updates they send to their existing customers explaining this change — it's doubtful that most homeowners fully grasped the importance of this change, or even read the notice.
Most homeowner's policies today include only "extended replacement cost" coverage or "specified additional amount of insurance" — this only provides coverage up to the dwelling limits specified in the policy plus an additional amount of up to 20 percent to 30 percent, and NOT a penny more.
This places more responsibility on homeowners to ensure that they have adequate dwelling coverage limits in their homeowner's insurance policies. The concern in the industry is that many homeowners have not updated their dwelling coverage limits and as a result are underinsured in the event that they have a full loss.
How Do I Set the Right Amount of Coverage?
To protect against underinsuring their home, homeowners should ask their insurance company to perform an analysis of their homes replacement cost, based on an inventory of the number and type of rooms, the quality level of the existing construction and the homes special features.
Ideally, the insurance agent should also visit the home to asses its replacement value and take into account the specific risks to the home, local market conditions and current building codes that would contribute to the costs of replacing the home.
Many insurance companies use MSB's computer program that calculates a home's replacement cost. You can also use a similar program offered by MSB at accucoverage.com.
On this site you can input information on your home and, for $7.95, receive an AccuCoverage report that will include an estimate of the insurable replacement cost of your home based on the same reconstruction cost data for your local area that is used by much of the insurance industry.
If you do not update your coverage and you have inadequate coverage limits in your policy, you may find that your current policy only insures a percentage of your homes current replacement value. Here is how it works: If you have a FULL LOSS of your home, and the dwelling limits of the policy are only a percentage of the full replacement cost of the home, you will only be paid the percentage of the replacement costs and not more than the limits in your policy. Chances are this gap in coverage will amount to a lot of money.
Do I have the Right Type of Coverage?
The two most common types of policies offered are HO-3 and HO-5 form of homeowner's coverage. Homeowners need to know the difference between the two. Only the HO-5 policies provide replacement cost coverage for contents damaged or lost due to all risks.
Having a guarantee that your home contents will be covered no matter what the reason for the loss is particularly important if you have a larger home, many furnishings, jewelry, art or a home office.
As more people buy vacation homes and second homes, they need to be sure to properly insure these homes, too. When buying or updating homeowners coverage on a second home, be sure to disclose to the insurance company that the home is a vacation home, the amount of time you occupy it and if you also offer it for rent when you are not using it.
Coverage for vacation/second homes should include additional liability coverage, loss of use and loss of rental income benefits.
Many insurance companies offer a dwelling coverage escalator. This feature automatically increases the dwelling limits in the policy each year. Ask your insurance company about this add-on, which can cost an additional $50 or so per year — a small amount to pay for additional peace of mind.
No standard home insurance policy will cover flood damage. Homeowners in flood zones can buy flood insurance under the National Flood Insurance Program through the Federal Emergency Management Agency, and claims are often serviced by your insurance company.
The maximum coverage available is $250,000 and the average cost is about $500 per year for $200,000 worth of coverage. If you need more flood insurance coverage, private insurers such as American International Group can provide policies with higher coverage limits.
Some owners of high-risk properties may have to resort to obtaining coverage through Fair Access to Insurance Requirements, or FAIR Plans, which are state mandated insurer organizations that cover high-risk properties in about 36 states.
Coverage for Loss of Use
One thing most homeowner's policies do cover is "loss of use." Many of the insured homeowners in New Orleans who were forced to evacuate their homes found that their costs to stay in a hotel and other related living costs were generally covered at an amount that is typically about 30 percent of the overall policy dwelling coverage.
So, for instance, if your home is insured for $200,000, you may be entitled to up to $60,000 in reimbursement for your expenses associated with your loss of use.
Keep in mind that if you do want to increase the amount of coverage on your home, you can't do so when the peril is upon you. Insurance companies generally place a moratorium on coverage changes in areas that are in the path of a storm, typically several days before the expected peril is forecast to strike.