By: Denise Koslowsky
The past two years have been blockbuster years for catastrophes in America. Climate change has led to an increase in the severity of storms and wildfires. The warming has triggered more than just changes in the earth’s atmosphere. It has led to increased insurance coverage rates and policy limitations. Never has it been more finite that there is an underinsurance epidemic in the U.S.
The Underinsurance Epidemic
Human nature leads most people to choose their insurance coverage based on price instead of value. Without full knowledge of the industry, what appears to be minor coverage differences may in fact be major, leading to gaps in coverage. Traditionally, most homeowners have insured their property for less than the replacement value, often unwittingly. To compound the problem, many insurance agents underinsure homes, and explain to the customers that their extended replacement cost “override”, plus the dwelling limit, equals enough coverage to rebuild the residence.
Time and time again when disasters strike, attention is brought to this crisis. Once the storm has passed or the fires burn out, the industry reverts right back to where it has always been, with little outreach or education for most consumers.
Over half this country is underinsured, and there’s a lot of data to suggest roughly 80 percent of the country is underinsured.
Kenneth Klein, professor at California Western School of Law in San Diego
Not All Carriers Are Created Equal
We witness the greatest evidence of underinsurance after a major disaster. These cases are often linked to mass market, standard insurers. There is a vast divide between the coverage provided by these insurers when compared to the specialty insurance carriers. Many consumers insured by a standard carrier believe their insurance policy will pay the total dwelling limit at the time of a loss.
This means in the case of a total loss, the insurer should rebuild the house at today’s prices with similar materials. If there is not enough coverage, there will be a delay before the case gets settled, which can translate to years. This is what many homeowners who have lost their homes to weather-related disasters have experienced. Their insurer didn’t cover the full replacement cost of their home.
Homeowners insured with specialty insurers have had a much different experience. In many cases, they not only receive a cash option, they also receive additional living expenses to pay for temporary housing for as long as it takes until their home is rebuilt.
Consider The Cost To Rebuild
Recent catastrophes have shown us that rebuilding costs dramatically increase when there is a spike in demand. This raises the question whether the standard homeowner’s policy meets the needs of consumers when thousands of homes are lost at the same time. Because there are so many variations, we’ll focus on homes valued at $750,000 or above in dwelling replacement. This same home might have a market value of only $500,000, which is the crux of the problem we are now facing in a soft real estate market.
The market value of a house has no correlation to the insurance replacement value.
This statement perplexes many consumers who often do not understand the mentality of insuring a house they just purchased for drastically more than they paid in market value. While this is not always the case, as the real estate market softens and beautiful homes can be purchased for much less than they historically have sold for, there is a lot of resistance from consumers who do not want to pay to insure their home for what it would cost to rebuild. Kathleen Tierney, President of Berkley One, adds “From a carrier’s perspective, this is truly the most common objection we hear— why should I pay premium on replacement cost when the market value of my home is less than that?” It’s natural that people don’t want to think about a loss situation that could lead to an expensive rebuild. But as common as this objection is in absence of a claim, there is not a claim I can recall where the client regretted having the proper valuation and therefore the proper coverage to restore fully to pre-loss condition. It’s hard work for the best agents to explain how this all works, but it is absolutely the best outcome for the client.” These same consumers are often not educated about the choices they are making or the coverage they are giving up.
Not All Agents Are Created Equal
To add to this dilemma, there are unscrupulous insurance agents who are willing to give the customer what they want, regardless of the consequences. For example, an agent might recommend that the consumer insure their $750,000 house for only $500,000, and by adding an extended replacement cost endorsement that provides 50 percent additional coverage. They explain that the house is still insured for $750,000, saving the insured hundreds of dollars on insurance premium. While the maximum cap on coverage would be $750,000, the whole point of the replacement cost endorsement is to provide an additional buffer to help negate the fluctuation of building materials, the spike in contractor costs after a disaster and the fact that the insurance dwelling limit is just an estimate until you actually attempt to rebuild your home.
Understanding That Coverage Is Often Capped
Unless your insurance policy contains explicit language which guarantees dwelling replacement without a cap in coverage offered, coverage is always capped. If there is an Additional Dwelling Replacement Cost endorsement, it will provide some limited additional coverage. Usually, this restricted coverage override is maxed out at 125 percent, but this endorsement can vary from carrier to carrier. State Farm historically uses 110 percent of the dwelling limit, and Allstate historically uses 125 percent.
The Importance Of Valuation
This is compounded by the shockingly limited technology that is used to determine an appropriate dwelling replacement cost limit by most insurance agents. Agents with these standard insurers guide consumers by using a Cost Estimator. They plug in basic information about a house, such as year built, square footage, type of construction (frame, masonry, masonry veneer, etc.), type of roof (asphalt, slate), and the software, (which most consumers believe is sophisticated) produces a dwelling limit. This limit hardly fluctuates no matter if the house is in Scarsdale, New York, or Kalamazoo, Michigan. In reality, estimating replacement cost is not as simple as it seems. It varies based on:
• Type of construction
• Quality of finishes
• Ceiling height
• Type of roof cover
• Cost of debris removal
• Slope of the lot
• Building codes (which can also cause drastic increases in replacement cost)
• Whether the home is custom or historic
• Quality of materials used
• Scarcity of skilled craftsmen available
Most standard carriers rely on the number that is produced by the cost estimator, regardless of its accuracy. Specialty companies send a person to physically inspect the home, which results in a more accurate estimate. Companies willing to pay to send an inspector generally limit the inspections to higher end homes. If the company is one of the few elite carriers in the marketplace, such as Chubb, AIG Private Client Group, PURE, Cincinnati, or Berkley One, it usually includes guaranteed dwelling replacement coverage.
Not All Insurance Is Created Equal
Not all insurance is created equal, and not all insurance policies provide sufficient ordinance and law coverage to address upgrades in building codes. There are huge variations in coverage, customer service, and quality of claims service.
How would you rather protect your investment: an online cost estimator that is
using generic materials or a physical inspection to identify the unique features in
There is not a human among us who would not wish to save money if they could
get the exact same product without giving up value. When switching carriers
and lowering your dwelling limit, unless you are still getting a cash option and
guaranteed dwelling replacement coverage, as a consumer, you have to ask
yourself if the savings justify giving up quality coverage.
A family’s home is one of their most valuable assets –both in terms of
comfort and financial security. Insurance that does not properly cover
the cost to replace or repair your home, nor provides replacement housing
during that repair, can impact a range of long-term financial outcomes,
such as saving for a child’s education or even retirement. Over the past
5 years we’ve seen an increase in the frequency of severe weather-related
events that have caused significant damages to peoples’ homes. With that
in mind, there has never been a better time to work with an independent
agent or broker to assess the policies you have in place and make sure your
coverage meets specific needs, such as addressing proper rebuilding and
repair of your home during an unanticipated event.
Fran O’Brien Division President of Chubb North America Personal Risk Services, and member of PRMA’s Board of Trustees.
Final Words of Advice From Advocate Brokerage
So many homeowners purchase their insurance when they buy their homes, and they set it and forget it forever. If your home is your most valuable asset, why not explore the many quality insurance agents and the companies they represent?
• Don’t be driven by premiums; Be driven by value and coverage
• Speak to a reputable builder and find out what they believe it would cost to replace your home, including all of the built-ins and finishing touches
• Purchase an insurance policy with a cash option
• Ensure your insurance policy includes guaranteed dwelling replacement coverage if available (in certain coastal areas, coverage is always limited)
• Take a higher deductible to save on premium, knowing that the insurance is really meant to indemnify you for a catastrophe and should not be used for every small potential claim
• Ask your insurance agent the difficult questions and find out how your policy will protect you if your house is underinsured at the time of a catastrophic loss
Now more than ever homeowners need to be working with agents who
consider themselves risk management professionals. Professionals who
will take the time to educate them about how to minimize the chance of
having a loss and who will make sure they have the proper coverage and
limits in place should a loss occur.
Lisa Lindsay the executive director of the Private Risk Management Association.
Never have we had clearer examples of an underinsurance problem than in the aftermath of the 2017 and 2018 California wildfires. So many California homeowners discovered they were not insured to value and had insufficient coverage to rebuild their homes. You might be amazed to discover that adequate coverage does not necessarily cost more and that you are actually overpaying to be underinsured.
Denise Koslowsky is a Principal at Advocate Brokerage Corp and a founding member of PRMA.