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Come Up Short on Insurance
August 31, 2004
EL CAJON, Calif. - Karla and Bruce Carroll remember the
sheriff on his bullhorn ordering residents to evacuate and,
minutes later, hearing the roar of monstrous flames arcing
toward their modest home here in the hills above San Diego.
Mrs. Carroll grabbed a family photo album as they ran to
safety; Mr. Carroll started to gather his fishing rods. But
she hustled him along. "Don't worry about those things,''
she recalls saying at the time. "We've got insurance."
But, the Carrolls say, the insurance they bought from State
Farm, the nation's largest property insurer, has left them
at least $100,000 short of the cost of rebuilding their
home. Today, nearly a year later, they are still wrangling
with their insurer and living in a 29-foot-long house
trailer on the land where their three-bedroom home once
stood, overlooking a spectacular sweep of ridges and
Their woeful shortfall in insurance coverage, experts say,
is a plight shared unknowingly by millions of American
homeowners. It has been fed largely by a shift in the way
property insurance has been sold in recent years.
In a move to cut costs from claims, insurance companies
began in the late 1990's to phase out coverage that
guaranteed the replacement of a destroyed home, regardless
of the expense to the insurer. In place of that unlimited
coverage, which had become nearly universal, insurers
substituted a similar-sounding policy with a crucial
difference: it pays only the amount stated on the policy
plus, typically, an additional 20 percent to 25 percent.
For their part, insurers insist that it is the consumer's
responsibility to acquire adequate coverage.
The old policy was called a guaranteed replacement policy.
The new one, which most Americans now have, is called an
extended replacement policy.
"People look at this and it says 'replacement' and theythink, 'That's good,
I get my house replaced,' " said John
Garamendi, the insurance commissioner in California. "But
they don't get their house replaced. They get money up to
the set limits plus the extended 20 percent or 25 percent."
Marshall & Swift/Boeckh, a Los Angeles company that most
insurers rely on for help in calculating the value of
houses, estimates that 64 percent of American homes are
underinsured by an average of 27 percent, with some homes
underinsured by 60 percent or more.
Another insurance industry company, AIR Worldwide in
Boston, estimates that many upper-income homes in New
England are underinsured by 30 percent to 40 percent.
"The underinsurance problem lies just beneath the surface
all across the country,'' said Robert P. Hartwig, the chief
economist for the Insurance Information Institute, a trade
group in New York.
The insurance gap has been worsened by the nationwide
housing boom that has been rapidly driving up the cost of
lumber, bricks, cement and other construction materials,
industry executives say. And in Southern California,
rebuilding costs soared even higher as the demand for
contractors and building supplies suddenly jumped after the
Carrolls' home and several thousand others were destroyed
in wildfires over a few days last October.
But such explanations do not satisfy the industry's
critics, who say insurers have shifted the burden of such
mistakes onto homeowners.
"Most people go to their insurance agent to buy coverage
and figure they're fully covered," said J. Robert Hunter,
the director for insurance at the Consumer Federation of
America. "But often they're not."
The issue of underinsurance has not attracted much
attention because, of the millions of insurance claims
every year, fewer than 2 percent are for the total loss of
a house. But the wildfires here last fall came as a jolt.
They quickly incinerated more than 3,700 homes and, Mr.
Garamendi said, "a very large proportion" of them were underinsured.
Consumer advocates and industry executives expect similar
problems for the victims of Hurricane Charley in Florida as
they begin working through their claims.
"The problem is everywhere,'' Mr. Hartwig said. "The
disasters simply expose it.''
George Kehrer, a lawyer and building contractor who founded
Community Assisting Recovery in Los Angeles more than a
decade ago to help people with insurance claims after
disasters, said he had spoken to 1,200 people who lost
homes in the California fires.
"About a dozen of them,'' he said, "were adequately
No single factor is entirely to blame for the underinsurance,
consumer advocates and industry executives say.
Homeowners, they say, need to recognize their own
But under pressure to make sales, Mr. Garamendi and
consumer advocates explain, insurance companies and their
agents often aim low in valuing houses. The goal, they say,
is to keep premiums down to keep customers from going to
competitors, and sometimes even a few dollars can make a
"If they quote a realistic replacement cost, the price of
the policy goes up," Mr. Garamendi said, "so they are
motivated to keep the replacement cost down."
Insurance industry executives argue that it would make no
sense to undervalue homes intentionally. The higher the
insurance coverage, the higher the premium, they point out.
But Mr. Garamendi disagrees. "You want the sale first," he
said. "O.K., you can get a little more premium if you give
full coverage. But you lose the sale."
Mr. Hunter, the consumer advocate, said agents often lacked
the training to assess accurately the value of a home,
done these days with the help of a computer program. Rarely
do the agents leave their
offices to assess a house personally,
agents and industry executives
Mr. Garamendi said some agents inadvertently undervalued
homes by using a computer shortcut to obtain what is known
as a "quick quote." Then, when a customer decides to buy
coverage, the agent fails to add details like designer
cabinets and fixtures that tend to increase the replacement
estimate and the cost of the insurance.
While most insurance policies include a built-in escalator
to keep pace with general inflation, the costs of building
supplies and paying for construction crews have been rising
at a faster pace, in many cases widening the gap between
the amount a house is insured for and what it will cost to
Another factor in the insurance gap has been a failure by
some homeowners to increase coverage after the spurt in
home improvements, from new kitchens to extra bedrooms, as
millions of Americans have used cheap money from mortgage
refinancings in recent years to upgrade their homes.
Still, in dozens of interviews over several days this
month, owners of the homes in Southern California that were
destroyed said repeatedly that they had been led to believe
they had bought enough coverage to rebuild their homes and
were stunned to find out they were wrong.
Mrs. Carroll said she first bought her insurance from State
Farm in 1998 shortly after she and her husband acquired
their home for $172,500.
"I told them I wanted full coverage for my house," she
said. "I've lived in this area most of my life, and I knew
there was a huge fire risk here. I had been evacuated for
fires three times as a child."
Two years later, she said, she checked back with the agent
to make sure she had enough coverage and increased the
coverage for possible additional costs as a result of
changes in building codes.
"I said, 'Are you sure this is enough to replace the house?'
said, 'Oh, that's plenty of coverage,' "Mrs. Carroll
recalled. "She had me
convinced my house could burn or fall down
the canyon under heavy rains and, yeah, it's covered."
At the time of the fire, the Carrolls' house was insured by
State Farm for $126,000, which, following standard
practice, did not reflect the value of the land. Their
annual premium was $730.
With 20 percent in extended replacement coverage and other
standard features including a built-in adjustment for
inflation and coverage on their two-car garage, fences and
driveway as well as an additional 25 percent for
anticipated building code changes - upgraded by Mrs.
Carroll from the usual 10 percent - the Carrolls estimate
their policy will pay them about $222,000. But Mrs. Carroll
said a contractor hired by State Farm estimated that
replacing their losses, not including their clothing and
other personal things, would cost nearly $400,000.
Bill Sirola, a spokesman for State Farm, said it was not
clear whether the Carrolls were underinsured. "We are
working with that family," Mr. Sirola said. "We are working
with other builders on their behalf to get other estimates
of their rebuilding costs."
As the insurance companies see it, if people are
underinsured it is primarily their own fault.
"It's the homeowner's responsibility to see that his home
is properly insured," said Mr. Hartwig of the Insurance
Insurers say the terms of coverage are clearly spelled out
in their policies. In California, insurers are also
required to mail a statement annually specifying the terms
of coverage along with renewal notices.
But many homeowners burned out by last year's fires say
they made clear they wanted to be able to replace their
homes. In interviews, they said they had no way of knowing
how much insurance they needed and relied on the agent to
set the proper value and charge the appropriate price. Many
say they would have been willing to pay more to
themselves that their losses would be fully covered.