Is your home underinsured? 8 key tests

By Liz Pulliam Weston

Karen and Bill Reimus aren't cheapskates about insurance. In addition to life and health policies, the self-described "insurance freaks" have earthquake and disability protection. They also sprang for extended replacement coverage on their pricey San Diego County home, figuring better safe than sorry.

"We try to prepare for a rainy day," said Karen, a mother of two who, like her husband, is a lawyer.

But it was fire, not rain, that proved their undoing. Four months after they bought their house in 2003, it burned to the ground in the Southern California wildfires, and the Reimuses discovered that their policy limits fell at least $150,000 short of what they needed to rebuild.

After talking with their Scripps Ranch neighbors, the Reimuses learned they had plenty of company. California's insurance commissioner estimated that 90% of those affected by the wildfires were underinsured. A 2006 survey by insurance-services firm Marshall & Swift / Boeckh puts the number nationwide at 58%, with those homeowners covered to rebuild about 80% of their homes.

How much?

Trying to figure out the right amounts of insurance coverage, however, is a tricky, frustrating process. Your insurance company or agent may be surprisingly little help -- and may even steer you wrong.

Many San Diego wildfire victims, for example, said their agents used a computer survey that vastly underestimated the cost of rebuilding their homes.

The survey, called Quick Quote, was part of a larger software package sold to insurers to estimate replacement costs. The company said agents should have used the more detailed software, which requires a longer interview with homeowners, to determine policy limits. Quick Quote was later removed from the software package.

Reimus said she was surprised that an insurance company would offer too little coverage, because such a practice limits the premiums it collects. She now suspects insurers actively avoid selling adequate coverage to reduce their exposure to loss.

Insurers deny that, although they do admit that some agents may lowball, or give quotes based on inadequate policy limits, to sell more policies.

Lulled into complacency

Insurance analyst Brian Sullivan has another take on the situation. He says the annual premiums paid on most policies are too small for insurers to spend much time doing a detailed assessment of the customers' needs.

"If you ask most insurance companies what they're insuring -- how many hardwood floors, how many fireplaces -- they have no idea," said Sullivan, editor of Risk Information, an industry newsletter. "It's only companies like Chubb that have (policies with) premiums in the thousands of dollars that will come out and appraise your home and everything in it."

Homeowners are often lulled into complacency because they have "guaranteed replacement" or "extended replacement" policies, which sound like they'll rebuild a home regardless of the cost, said attorney Amy Bach of United Policyholders, an advocacy group for insurance consumers.

But true guaranteed-replacement policies are almost extinct, and virtually all insurers cap the payouts at 100% to 150% of the amount for which the home is insured.

Bach recommends consumers buy the highest cap they can afford, and take the following steps:

Know your replacement costs per square foot. Divide your home's policy limits, which are listed on the "declarations" page, by your home's square footage. Compare this to a custom-home builder's estimate of what it would cost to rebuild your house, with its current amenities. If your insurer can't explain discrepancies to your satisfaction, start shopping for another insurer.

Don't be cheap. Make it clear to your insurer or agent that you want the best coverage for your money, not the lowest possible premiums.

Check your "loss of use." Homeowners policies typically provide money to pay your rent and related living expenses while your home is being rebuilt. Again, you should find this coverage on the declarations page. If the amount offered wouldn't cover you for two full years, Bach recommends asking for a higher limit or finding another insurer.

Get "replacement cost," not "actual cash value." It's not just rebuilding coverage that falls short. Many policies severely restrict how much money you'd get to replace your stuff, and limit or even exclude some common household items from your policy. If you have a policy that pays out "actual cash value" on your home's contents, for example, you'll get a check for what your possessions were worth when they were destroyed -- not what they would cost to replace. It's much better to spring for "replacement cost" on your contents, and get a check for what you would need to buy a new item. The cost of this coverage is typically about 10% to 20% more than actual-cash-value coverage.

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