Legal Definitions - underinsurance

Underinsurance occurs when the amount of insurance coverage purchased for an asset is less than its actual market value or the full cost to repair or replace it.

In simpler terms, if your property is damaged or destroyed, and you are underinsured, the payout from your insurance company will not be enough to cover the entire loss. This means you would be responsible for paying the difference out of your own pocket.

Here are some examples to illustrate this concept:

• Homeowner's Policy: Imagine a homeowner purchased a house for $300,000 several years ago and insured it for that amount. Over time, due to inflation and rising construction costs, the actual cost to rebuild the house from scratch has increased to $450,000. If a fire completely destroys the house, and the homeowner has not updated their policy, the insurance company might only pay out the original $300,000 coverage limit. This leaves the homeowner with a $150,000 shortfall, meaning they are underinsured for the true cost of rebuilding their home.

• Business Property: A small business owns a warehouse full of inventory and machinery with a total replacement value of $2 million. However, the business owner, perhaps to save on premiums, only purchased a commercial property insurance policy with a maximum coverage limit of $1.2 million. If a natural disaster, like a flood, destroys all the contents of the warehouse, the insurance company will only pay up to $1.2 million. The business would then be responsible for the remaining $800,000 needed to replace its assets, demonstrating a significant case of underinsurance.

• Valuable Personal Items: Consider an individual who owns a collection of antique watches valued at $75,000. Their standard homeowner's insurance policy includes a general limit of $10,000 for unscheduled jewelry and collectibles. The owner never had the watches appraised or specifically listed them on their policy. If the entire collection is stolen, the insurance company would only pay out the $10,000 general limit, leaving the owner with a $65,000 loss. In this scenario, the valuable collection was significantly underinsured because its specific value was not adequately covered by the policy.