Property Undervaluation Can Wreak Havoc with Insurance Claims

Is your home’s value understated on your homeowners insurance policy? While it may not seem like a big deal, property undervaluation could become a problem if you have to report a claim – even if the claim is for less than your policy limit. To make sure you have sufficient coverage, it’s important to maintain an accurate home valuation.

How Home Values and Insurance Limits Work

For the purpose of insurance, your home’s value is not the same as its market value.

When you buy or sell a house, you’re buying both the structure and the land it’s built on, which the market value reflects. Depending on the property, the land may be worth a lot more than the house.

However, if a disaster were to destroy your home, you would still have the land, even if you had to completely rebuild the structure. Therefore, dwelling insurance values are based on the value of the building. For insurance purposes, there are two values to keep in mind:

• Actual cash value. This is the current cash value of the structure, which may be significantly less than the price you paid, due to depreciation. For example, your roof may have cost $10,000 when it was new, but now that it’s nearing the end of its life, the actual cash value may only be $5,000. If your roof is destroyed and your policy provides actual cash value, the payout may not be enough to cover the necessary repairs.
• Replacement cost. This is the cost to repair or replace the insured property. It may increase over time due to inflation. For example, you may have paid $10,000 for a new roof several years ago, but the same new roof now might cost $15,000, due to increases in labor and material costs. Replacement cost coverage is superior to actual cash value coverage, but it’s important to ensure your limits are high enough.

Many Homes Are Undervalued

Property values have surged in recent years, as have construction costs. According to Verisk, residential reconstruction costs increased by 63.7% between October 2014 and October 2024. If your homeowners insurance policy hasn’t kept up, you may be seriously underinsured.

Many homeowners are reluctant to raise their limits, as a higher limit will necessitate a higher premium. Worse still, insurance costs have risen dramatically, and homeowners are also struggling with higher property taxes, groceries, and other costs.

Nevertheless, it’s important to have adequate insurance. Otherwise, if a disaster destroys your home, you might not have nearly enough coverage to rebuild. Many homeowners in California are experiencing this after the Los Angeles area wildfires. According to researchers from the University of Colorado Boulder, 74% of the policyholders who reported losses are underinsured and 36% are severely underinsured.

Even if you don’t suffer a total loss, insufficient coverage may result in lower payouts due to a common policy term known as the coinsurance clause. This requires policyholders to insure their property for a minimum percentage of its actual value – for example, 90% or 80%. If they don’t maintain this level of coverage, the insurer will reduce ANY claim payouts in proportion to the level of underinsurance. This is often called the coinsurance penalty.

How to Protect Your Home

You never know when the next fire, storm, or other disaster will strike. Talk to your insurance agent and make sure you have sufficient coverage.

• Review your limits. You may need to raise your limits in light of rising reconstruction costs.
• Secure guaranteed replacement cost value coverage. Guaranteed replacement cost value provides additional protection against inflation by covering the full cost to repair or replace your property, even if this cost exceeds your policy limit.
• Check your coverage types and exclusions. High limits won’t help if your policy excludes the cause of loss. In Hawaii, homeowners may need flood and hurricane insurance in addition to homeowners insurance.
• Work with an agent. An agent will help you understand your coverage needs and make sure you have sufficient protection.

Do you need to check the stated property value and coverage types in your homeowners insurance policy? Find an agent.