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Your Financial Future: Is Your Home at Risk Because It’s Underinsured?

Losing a home and not being able to replace it would be a blow to most families’ finances.

It was one of those things that you look at, file away and forget. The letter from my mortgage company said that it appeared my house was underinsured. It wasn’t until more than a year later, after I read High Wire: The Precarious Financial Lives of American Families, by Peter Gosselin, that I dug the letter out of the file to find out whether I had adequate coverage.

I was lucky: It turned out the mortgage company had the wrong policy number and I was adequately insured. But an estimated 66 percent of U.S. homes are underinsured by an average of 18 percent, according to a recent survey. Most families only find out the hard way—after their homes are destroyed.

That’s what happened to Julie and Dan Peck, whose avocado farm and the house where they had lived for 35 years were burned to the ground by wildfires that swept through Fallbrook, Calif., in October 2007. The Pecks had been evacuated by the sheriff’s department; when they returned, only chimneys were standing. The house where they raised their four children, the outbuildings and the avocado trees, which they used to supplement their retirement income, were all gone.

“Everything in the house was decimated and everything around it,” said Julie Peck. “All those years of hard work. Our heart and soul went into that place, and it was destroyed completely.”

Peck said when the insurance company inspected the house many years ago, it set the coverage amount, and they hadn’t built on any additions since. They assumed that the policy was adequate because, said Peck, they were “assured by the insurance company that the yearly increases in coverage were keeping up with rising building costs.” But after the fire, they learned that their insurance coverage was only for about half of the estimated cost of rebuilding the same home.

In the 16 months since the fire, the Pecks, who are 68, have been living in rental housing, paying to clean up and maintain their old property and watching their retirement savings being ravaged by the market. “We can’t rebuild,” she said. “We can’t sell. And we can’t really afford to take on debt to go buy another place, so we’ve just been constantly trying to figure out how to handle this situation.

Losing a home and not being able to replace it would be a blow to most families’ finances. As Gosselin points out, “For the great majority of Americans, by far the most valuable single asset they will ever own is the house they live in.” According to a survey of consumer finances published by the Federal Reserve, in 2007 the primary residence accounted for 31.8 percent of total family assets. For the least wealthy homeowners, it was 47.1 percent.

Most homeowners may think that their investment is properly insured. But over the years many insurance companies have replaced what had been called “guaranteed replacement cost” coverage with “extended replacement cost coverage,” which is a dollar amount. It’s that dollar amount that you need to be sure of and know whether it would really cover the cost of replacing your home.

J. Robert Hunter, director of insurance for the Consumer Federation of America, said that the insurance industry has been making efforts in recent years to get homeowners to ensure to the proper value. But he added, “It’s still a serious problem, particularly if you live in a high-risk area.”

United Policyholders, a nonprofit group that provides insurance advice and assistance to consumers, surveyed victims of the 2007 wildfires in California and found that, among those who were underinsured, the average amount was more than $200,000, according to Amy Bach, executive director.

Bach said that underinsurance is the product of intense competition among insurers. The lower the cost of replacement, the lower the price of insurance, said Bach, who would like to see sellers made legally liable for underestimating replacement costs.

Buyers have a natural tendency not to question whether the replacement value is high enough, she said. For one thing, not many homeowners lose their homes entirely. There is also “consumer reluctance to pay for something they can’t see, hope they will never use and don’t like anyway,” she said.

Martha M. Hamilton, a former writer and editor for the Washington Post, writes a regular column, Your Financial Future, for AARP Bulletin Today.

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