Are You Underinsured? (Part 1)
Part 1 of 2: Understanding the Problem
Property values are rising across the United States. That’s good news for homeowners, right? Yes… and no! Yes, because your home has likely appreciated in value. No, because — if you’re like the majority of homeowners — you probably haven’t revisited the coverage levels in your homeowners insurance policy since you bought it. And that may mean you could be underinsured.
You’re not alone. According to analytics firm CoreLogic, three of every five homes in America are underinsured by an average of 20%. According to Nationwide Insurance, as many as two out of three homes in America are underinsured by an average of 22%, and some homes are underinsured by 60% or more. Whichever way you slice it, more than half of American homeowners are underinsured. Are you one of them?
What Can Happen if I’m Underinsured?
If your home is impacted by a natural disaster, being underinsured could mean major financial loss and out-of-pocket expenses. It could mean you’re unable to rebuild. It could mean your insurance carrier has the right to make reduced payouts on any claims you make. In a worst-case scenario, it could even cause you to lose your home.
Unfortunately, many homeowners only discover they’re underinsured when they file a claim. Here at Covered, we want to help you avoid the high costs, heartache, and inconvenience of learning you’re underinsured when it’s too late to do anything about it. That’s why we want to help you make sure you’re covered now.
Because here’s the bottom line: Underinsurance is something you can fix. And it’s absolutely worth fixing. After all, if you’re like most of us, your home is one of your biggest investments and assets. If your home is at risk, so is your financial future.
Below, find out what it means to be underinsured, how you might become underinsured, and steps you can take to check and fix your coverage. Let’s get you covered already!
What Does It Mean To Be “Underinsured”?
If you’re underinsured, your homeowners policy coverage is insufficient to cover the cost to rebuild your home if it’s damaged or destroyed by a covered cause of loss.
Let’s say your home is insured for $300,000 with a $5,000 deductible. If your home is destroyed by fire, you’ll make a claim with your insurance carrier so that you can rebuild. If the actual cost to rebuild your house is $400,000, you’ll — at the very minimum — be out of pocket for the difference as well as the deductible: $105,000.
The more likely scenario, however, is that you’ll be out of pocket for far more. Why? Well, the most the insurance company will ever pay is the dwelling limit listed on your policy.
Most policies also require that you insure your home to at least 80% of the actual amount required to rebuild. If the damaged home is insured for 80% or more of the full replacement cost, then replacement cost valuation will be used subject to the lesser of the policy limit or the repair or replacement cost. If the insured home fails the 80% coinsurance requirement, then the loss is settled on actual cash value (ACV).
What Could Cause Me to Become Underinsured?
Most homeowners don’t intentionally underinsure their homes. So how does it happen? We’ve covered the most common reasons below.
Rising Property Values & Rising Construction Costs
Many homeowners assume their homeowners insurance coverage is automatically adjusted for changes in home value. Indeed, most policies are adjusted for inflation and rising values — but only to a degree. Unless you’ve opted in for specific types of coverage, it’s likely that the cost to rebuild has risen more quickly than your policy is accounting for.
When it comes to rebuilding, what matters are your construction costs. Rising construction costs are a natural part of inflation. In addition, the localized costs of building materials, permits, and design/build labor tend to rise alongside increasing property values. Construction costs also tend to rise along with the spikes in demand that follow natural disasters. Finally, building code changes may impact your cost to rebuild. Depending on when your home was built, you may be required to rebuild certain components (e.g., electrical, structural, sewer, etc.) so that they meet current building code standards.
That said, once all mortgages, home equity loans, and HELOCs are paid off, some homeowners may choose to update their coverages to reduce their premiums. For example, a mortgage-free homeowner may choose to go with a higher-deductible policy. Though it means they need to be prepared to cover all out-of-pocket costs required to meet that higher deductible on any claims, they’re covered if a catastrophic event occurs.
Underestimating the Risks of Natural Hazards or Disasters
It’s natural to want to downplay the natural hazard risks surrounding our homes. Still, no matter where we’ve built or bought, our homes are susceptible to the forces of nature. Even in states that have never seen an earthquake, the earth is always moving. Heavy rain, sewer backups, or even an overflowing toilet can cause severe water damage to any home, no fancy hurricane needed. You get the idea.
That’s why it’s important to educate yourself on which natural hazards your specific homeowners policy does and doesn’t cover. Typically, standard homeowners insurance policies:
- DO cover damage from fire, smoke, hail, windstorms (e.g., tornadoes, hurricanes), lightning strikes, explosions, falling objects, and the weight of ice, snow, or sleet.
- DON’T cover damage from floods, earthquakes, landslides, mudslides, sinkholes, or coastal storm surges.
- DON’T cover damage caused by mold, infestations, or sewer backups.
- DON’T cover damage caused by lack of maintenance. For example, heavy rains that seeped through a leaky roof you failed to fix? Not covered.
- DON’T cover the cost of replacing valuables such as fine jewelry, antiques, collectibles, or art.
Failing to be realistic about the natural hazards that may impact your property can be disastrous. Just ask the owners of the more than 100,000 homes that were affected by 2017’s Hurricane Harvey. CoreLogic estimated that 75 percent of Harvey’s flood damage to residential properties was uninsured.
Errors in Your Policy’s Property Description
Your home’s valuation is part of the data used to calculate appropriate coverage. If the information your insurance carrier has is wrong, your valuation could be incorrect — which in turn means your coverage could be incorrect. Incorrect valuation may be caused by:
- Insufficiently detailed information about your home’s finishes (i.e., what type of flooring, counters, woodwork, roof, exterior wall construction and style, and special features your home has)
- Incorrect square footage figures
- Incorrect data on number of bathrooms, bedrooms, and other rooms
- Failure to update your agent about home renovations (e.g,. remodeling, additions) completed since the policy was purchased
As we’ll cover in more detail below, no single replacement cost estimate is infallible. In addition, some homeowners make mistaken assumptions about how home valuation should be calculated. For example:
- Neither market value nor purchase price equal construction cost. The price you paid may be more or less that it will cost you to rebuild. That said, in highly inflated markets, basing your insured value on your purchase price could mean you’ve OVERinsured.
- Covering the value of your mortgage may be inadequate. Again, what matters is the cost to rebuild.
- ACV calculations are almost never the way to go. Standard policies tend to use ACV to cover personal property. Sure, if you use ACV to calculate replacement costs, your policy costs less. But it means insurers only need to reimburse you for the depreciated value of your items. In other words, if you need to replace a 10-year-old toilet lost in a fire, you’re only going to be paid the depreciated cost of that 10-year-old toilet… which clearly isn’t going to be much.
Um, You Were Being Cheap
Many homeowners can’t help chasing the cheap policy. And while at Covered we’re all about helping you find affordable insurance, there are some places you really can’t afford to skimp. In particular, homeowners insurance is not a good place to gamble. Is bare-minimum coverage the right choice for one of the most important investments you’ve ever made?
In addition, those minimum coverages aren’t so great. For example, minimum homeowners insurance liability protection is usually $100,000. In actuality, experts recommend having from three to ten times that coverage.
What Steps Should I Take to Make Sure I’m Properly Covered?
So how can you make sure you’re NOT underinsured? And that you’re paying for the right coverage in the right places? Check out part two of our “Are You Underinsured?” blog series, “Fixing the Problem.” We provide step-by-step instructions to help you determine your cost to rebuild, create a home inventory, and methodically review and update your policy coverages.
How Can Covered Help?
At Covered, we’re committed to making insurance easier while empowering you with the information you need to make choices that are right for you. If you’d like to get moving on comparing different coverages and premiums, get started on a new quote or talk to one of our agents today.
Don’t Worry. Get Covered.
Cover Photo by Luis Quintero on Unsplash