It’s my wife’s fault. After watching a series on the DIY Network, she asked me to teach her how to use a chop saw and air nailer. Now one home improvement project follows another and my weekends are booked through retirement. It took six months, but she recently finished turning the empty space above our garage into a guest room, complete with separate bath. That’s when it struck me that we were underinsured.
Our situation was not unique. Fewer than half of all U.S. homeowners receive enough from their insurance policy to fully rebuild their home after it is damaged. According to Marshall & Swift, 60% of homes in the U.S. are undervalued for insurance by an average of 17%. That means that for every $100,000 of home value, most owners fall short by $17,000 in protection. Many homeowners don’t check to ensure their home is appropriately valued or that their insurance coverage keeps up with inflation, but for what reason?
Why Would Someone Underinsure Their Home?
Some homeowners choose to lower their insurance limit to save money. However, with home insurance, the opposite will often occur. Saving a few hundred dollars a year may seem like a prudent decision until a claim takes place. Even with minor damage it can take decades of such savings to make up for being underinsured on a single claim, especially if an underinsured penalty is added. We will explain underinsured penalties a little later in the article.
This was our issue. Homeowners often renovate and add to their homes. In fact, the Joint Center for Housing Studies of Harvard University estimates homeowners spend $400,000,000,000 each year on improvements and repairs. That’s $400 billion, with a “b”. And the trend is rising, especially with the need to spend more time at home due to COVID. Renovations add value, but if a homeowner doesn’t adjust their insurance policy limits afterwards, they are short on protection.
Even if you simply maintain your home as-is, after several years your house will be underinsured due to inflation. Inflation averages around 2% each year. That sounds so little, but consider it over time. If left unchecked for three years, that makes it 6%. If you have a $250,000 home, that equates to a $15,000 insurance shortfall.
Material Cost Fluctuations
This last summer new neighbors built a home across the street from us and the cost of materials increased 20% in only three months. From the time they broke ground to the time it was complete, materials had skyrocketed. Much of the cost increase was due to higher demand and lower supply due to COVID, but similar fluctuations for other reasons are not uncommon.
Penalties for Underinsurance
Being underinsured can limit a payout in two ways. The most obvious is simply by not providing the level of coverage needed. If a $250,000 home is destroyed by fire and the client only carried $230,000 of coverage, they are short $20,000.
However, being underinsured can harm a homeowner in a second, less understood manner. Most home insurance policies set a coverage minimum requirement of 80% of the cost to replace/rebuild the home. If the home is not insured at that level, an additional penalty will be added to the payout. This is called a coinsurance penalty and it works like this: A claim payment will be reduced by the percentage the home was underinsured.
For example: Suppose the same $250,000 home is insured for $125,000. You would think that, if it was destroyed, the homeowner would get the full $125,000, right? No. Since the home was only insured at 50% of the cost to replace it, the claim payment will be reduced by 50%. That means that instead of receiving $125,000, they will only receive $75,000. This is a simplified example, but it proves the point. In such a scenario, insurance companies aren’t trying to get out of paying a claim. Rather, insurance policies rely on adequate coverage being carried, necessitating a coinsurance penalty if not.
Ways to Ensure Proper Insurance Value
Although your insurance agent and your insurance company may advise you, it is up to each homeowner to ensure proper levels of coverage are maintained. Take the responsibility seriously.
- Purchase a rebuilding cost estimate from a qualified general contractor.
- Provide your insurance agent with accurate information about your home’s size, layout, and distinctive features. Your home’s unique qualities may add to its value, so carefully give full details.
- Use a component-based valuation system to estimate the cost to rebuild your home. These programs estimate the cost to rebuild a home based on its construction and extra features. They also account for local factors to ensure up-to-date labor and material costs. Before completing one of these online, ask your insurance agent whether they can provide one for you.
- Review your homeowners insurance policy with your agent annually. Those phone calls or letters you receive each year from your agent are for good reason. An annual review helps ensure coverage keeps up with inflation and construction costs.
- Increase your insurance coverage when you remodel or repair your home. You put a lot of time and expense into maintaining and fixing it up. Don’t let those efforts go to waste.
Questions on your home insurance? Policies vary, so review it carefully or contact your Bankers Insurance agent. We will help determine your risks and advise how to best cover them. Not a client of ours? Let us earn your business! Each of our clients is assigned a personal insurance agent and provided their email address as well as a phone number that rings right on their desk.