Surge in Home Prices Leaves
Homeowners Underinsured

It's the downside of the housing boom: Many homeowners are now significantly underinsured.

Americans have been pouring money into their homes in recent years, adding everything from marble bathrooms to fancy backyard barbecues: Last year alone, spending on improvements like these hit an estimated $155 billion, up 27% from two years earlier. At the same time, the global boom in commodities prices -- lumber, copper piping and other necessities -- as well as rising labor costs has pushed up replacement costs by 7% a year since 2001.

As a result, people who haven't updated their insurance policies in a few years may now be underestimating what it would cost to rebuild their homes, particularly in high-priced markets.

According to a survey to be released soon by Marshall & Swift/Boeckh LLC, a firm that supplies building-cost data to insurers, 58% of houses are undervalued for insurance purposes. Of those, the average homeowner has enough insurance to rebuild only about 80% of his or her house, according to the survey.

Meantime, many insurers have been quietly cutting back what their policies cover. Allstate Corp. recently stopped covering earthquake damage in most states. Several insurers, including State Farm Insurance Cos. and Farmers Insurance Group, a unit of Zurich Financial Services, have stopped covering wind damage in some coastal areas that have been threatened by hurricanes.

One of the biggest shifts by insurers in recent years has been the virtual disappearance of "guaranteed replacement cost" coverage, which promised to rebuild a home exactly the way it was, no matter the cost. Now, most standard policies provide only "extended replacement cost," which offers up to 20% or so more than the face value of the policy if extraordinary events push up rebuilding costs.

Insurance experts say many homeowners haven't grasped this shift, and may be woefully underinsured as a result.

Home insurance exists to help owners repair or rebuild a home, and replace furniture, clothing and other personal property, in the wake of a fire, burglary or other calamity covered by the policy. Some risks, such as flooding or acts of war, are routinely excluded. (Policies also include liability coverage to protect against lawsuits resulting from incidents around a home, such as your dog biting the cable guy).

For insurance purposes, the value of a house is based mostly on the rebuilding costs in a particular area, not on its market value. The policy isn't meant to include the value of the land underneath, which is why some homes, especially in desirable neighborhoods where land is pricey, need less insurance than the amount they would fetch in a resale.

Homeowners need to pay close attention to what's in their policies, because insurers are regularly fiddling with the coverage. Insurers notify policyholders about coverage changes in the annual policy-renewal statement, but many homeowners don't bother to read it, focusing only on the premium.

"Take the new policy, and the old one, and put them side by side -- and if you have questions, contact the company," says Don Griffin of the Property and Casualty Insurers Association of America. It's also a good idea to have a face-to-face meeting at least once a year with your insurance agent or broker, at renewal time.

Some consumer advocates have blamed insurers themselves for homeowners being underinsured, saying their agents lowballed replacement costs in order to keep premiums competitive. Over the past few years, spurred in part by lawsuits, insurers have taken steps to improve their estimates, industry officials say.

That is what Ross Quigley of Mount Lemmon, Ariz., says happened to him. In 2003 a mountain cabin he owns in this vacation community near Tucson was destroyed by wildfire, along with hundreds of other homes. The retired real-estate broker had a $160,000 policy, but he learned that rebuilding the 1912 structure was going to cost $500,000 because of its unusual features and remote location. Mr. Quigley says his insurer had "told me not to worry, because I had 'replacement value,' " a provision in the policy that stipulates he would receive the value of his home without subtracting for depreciation. "But that was so misleading," he says.

He sued the insurer, alleging the company had acted in bad faith by seriously underestimating the amount of insurance he needed. The matter was settled out of court late last year.

Homeowners with unique, historical or custom-built houses might not be able to find adequate coverage from mass-market insurers, which typically pay to rebuild using only standard materials and construction techniques. These owners might have to turn to a specialty insurer, such as Chubb Corp., American International Group Inc. and Allianz AG's Fireman's Fund Insurance Co.

Here are three key questions for an insurer during a checkup:

Do I have enough insurance to be able to rebuild my home as it is, and replace my personal possessions?

Your agent should be able to tell you, but for $7.95 you can check by using a replacement-cost calculator provided by Marshall & Swift/Boeckh at www.accucoverage.com. It uses information you report about your house, and the construction-cost data that the insurance industry uses. Detailed estimates can be obtained from local building contractors, or by paying a professional appraiser.

Coverage for the contents of the home is pegged, usually at about 50%, to the insured value of the house. When calculating your needs for personal property, take an inventory of your possessions, or make a video.

Don't forget to include art, jewelry or unique collections that might require special riders or a separate policy -- a frequent oversight. Most homeowner policies generally cover jewelry only up to $2,000, and antiques are only covered for their value as furniture.

How much am I covered for liability for damage or bodily injury to others?

A standard homeowner policy includes coverage from $100,000 to $300,000. Umbrella liability policies provide coverage in excess of home and automobile policy limits, in increments of $1 million, at prices beginning at about $200 a year. Affluent homeowners vulnerable to litigation because of their deep pockets may want to consider the additional coverage.

Am I adequately covered for the cost of additional living expenses if my home is damaged and I have to live somewhere else during repairs?

This part of the policy reimburses you for hotel bills, restaurant meals, etc. Most policies provide about 20% of the insured value of the house for living expenses. Higher limits are available from some insurers.

Email your comments to rjeditor@dowjones.com.