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Too much house, too little insurance
Many homeowners lack sufficient property coverage

By Ray Martin, CBS.MarketWatch.com

BOSTON (CBS.MW) -- While most homeowners have homeowner's insurance policies, many homeowners are not adequately protecting their homes. According to Marshall & Swift /Boeckh, publisher of the Residential Cost Handbook and a supplier of local building-cost information to the property and casualty insurance industry, 64 percent of homes in America are underinsured by an average of 27 percent. Robert Hartwig, chief economist for the Insurance Information Institute, agrees that the underinsurance problem exists all across the country.

And this underinsurance problem is painfully exposed when homeowners face a total and unexpected loss as have many in California and in Florida. According to John Garamendi, the California Insurance Commissioner, a large proportion of the more than 3,700 homeowners who suffered a total loss due to the wildfires there last year are finding out that the money their insurance is providing is falling far short of what they need to rebuild.

In an industry that prides itself on customer service and providing security to its customers, it's difficult to believe that property-insurance companies would knowingly allow their customers to underinsure their homes. After all, buying the right amount and right type of insurance means larger policy premiums and profits for the insurers.

Add to that the fact that among the millions of insurance claims totaling approximately $26 billion a year; fewer than two percent are for the total loss of a house.

Pointing fingers

So why is this happening? Insurance companies are quick to point out that homeowners all too often do not step up to the responsibility of buying adequate coverage for their homes. When homeowners remodel and improve their homes, they often forget to follow through with a call to their insurance agent to update their coverage.

Another contributor is the surging price of lumber, steel and other building materials and the rising costs due to new building codes. Escalating labor costs also contribute to higher construction bills.

Consumer groups such as the Consumer Federation of America, however, paint a much different picture. They say that homeowners depend on their insurance agents to properly assess replacement values and to sell them the right type and amount of coverage.

They say that many agents today lack the training to properly asses the value of the homes they insure and often rely on over-the-phone interviews and computer-program estimates to provide quick quotes to close a deal in the competitive world of selling homeowners insurance.

The result is that consumers often buy cheaply priced coverage that they falsely believe will replace their home in the event of a full loss.

A need to know

Every homeowner needs to know that the old-fashioned "guaranteed replacement coverage" that provided homeowners peace of mind that their home would be replaced regardless of the rebuilding costs is quickly becoming a thing of the past. Most homeowners policies sold today are called "extended replacement coverage" or "specified additional amount of insurance," which only provides coverage up to the dwelling limits specified in the policy plus an additional amount of up to 20 to 30 percent -- and not a penny more.

And if you have an existing policy with "guaranteed replacement coverage" expect a notice from your insurance company upon the policy anniversary that your current coverage will replaced with this new and more limited form of coverage.

This development places more responsibility on homeowners to ensure that they have adequate coverage.

Some insurance companies say they have been forced to limit replacement coverage as homeowners have been slow to increase their coverage limits as home values appreciated and rebuilding costs have surged. But some insurance company representatives fear that as this new coverage is rolled out to existing policy holders, homeowners will do nothing and as a result will be underinsured -- and ignorant about it.

Assessing replacement value

To protect against underinsuring their homes, homeowners should insist on a through analysis of replacement value, including an inventory of the number of rooms and bathrooms and specification of the quality level of the existing construction as well as any special features.

Many insurance companies are now using Marshal & Swifts Residential Component Technology home-valuation program to calculate replacement values and suggesting this as the proper coverage limits to set in your policy. If this valuation is incomplete, and the homeowner does not buy enough coverage, the homeowner will bear the consequence.

Ideally, the insurance agent should also visit the home to asses its replacement value and take into account the specific risks to the home, local market conditions and current building codes that would contribute to the costs of replacing the home.

Homeowners also need to know the difference between HO-3 and HO-5 form of homeowner's coverage -- these are the two most common policies offered. While both forms of coverage insure damages caused by all risks to a home's physical structure, the fundamental difference is that only the HO-5 policies fully cover damages and loss of the home's contents due to all risks.

Having a guarantee that your personal belongings will be covered no matter what kind of disaster strikes is particularly important if you have a larger home, many furnishings, expensive jewelry, art or a home office.

Homeowners with outdated policies may find that their current policy dwelling limits only insures a percentage of their homes' current replacement value.

It is important to note that as long as your dwelling limits in your policy are 80 percent of more of the replacement cost of the dwelling, you are fully covered for a partial loss. But if you have a full loss of your home, and you do not have the full amount of the dwelling replacement value covered, you will only be paid for part of the replacement costs -- and chances are this gap in coverage will amount to a lot of money.

Also, many homeowners have upgraded their homes and these improvements boost the home's replacement value, meaning insurance limits should be increased accordingly. Finally, not only have home values gone up, the price of materials and labor has also increased. Homes lost in disaster areas typically have to be rebuilt to conform to new building codes, to protect against wind damage or earthquakes for example, adding to the costs to rebuild the home.

Many insurance companies offer a feature that automatically increases the value for which the home is insured each year. Ask your insurance company about this coverage escalator. The cost of this rider and coverage increase is then automatically built into your premium each year.

If the home is located in a flood plain, no policy will cover flood damage. The federal government provides flood insurance through the Federal Emergency Management Agency, and claims are often serviced by your insurance company.

Some owners of high-risk properties may have to resort to obtaining coverage through Fair Access to Insurance Requirements, or FAIR Plans, which are state mandated insurer organizations that cover high-risk properties in 36 states.

Put out

One thing most homeowner's policies do cover is "loss of use." Many Florida residents have been forced to evacuate their homes as the recent hurricanes descended on their area.

What these homeowners need to know is that their costs to stay in a hotel and other related living costs are generally covered at an amount that is typically about 30 percent of the overall policy dwelling coverage. If your home is insured for $200,000, for instance, you may be entitled to up to $60,000 in reimbursement for your expenses associated with your loss of use.

Keep in mind that if you do want to increase the amount of coverage on your home, you can't do so when the peril is upon you. Insurance companies generally place a moratorium on coverage changes in areas in the path of a storm, typically several days before the expected peril is forecast to strike.

Certified Financial Planner Ray Martin writes on personal finance for CBS.MarketWatch.com and also appears on the "The Early Show" on CBS. He is co-author of "The Rookie's Guide to Money Management."

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