Magnifying Disaster: The Causes and Consequences of Home Underinsurance

Abstract

Existing surveys demonstrate that in the United States, most homeowners believe that their home insurance coverage will cover the complete costs to rebuild their home in the event of a total loss. Yet, most dwellings are insured for an amount that is less than what would be required to rebuild -- a condition called "underinsurance."

By conducting historical research on the United States home insurance market, I show that insurers have recognized underinsurance as a problem afflicting the home insurance market in every decade since the Depression. Insurers have repeatedly

attempted, and failed, to resolve inadequate insurance-to-value -- through salesmanship, innovations in valuation methodologies, and automation. This result complicates theories of inadequate insurance, drawn from insurance economics, that explain inadequate insurance as primarily a problem of demand. A longstanding supply-side problem of accurate property valuation has contributed substantially to widespread, persistent underinsurance.

Using fieldwork conducted after the 2003 and 2007 San Diego wildfires, I show how pre-loss policyholder experiences supported their expectations that their home insurance would be sufficient: analogical reasoning from small losses to large losses; interactions with insurance agents; and legal consciousness of the insurance contract. This case demonstrates how the presence of information asymmetry in a market can accompany "false certainty" of transaction outcomes -- not just perceived uncertainty of transaction outcomes -- among low-information parties to transaction. Market features that are often credited with reducing uncertainty need not always equip market actors with better knowledge; these conditions can elide potentially variable transaction outcomes, consequently contributing to widespread market misconceptions.

In contrast with most existing disaster recovery studies, I find that even households with reputable insurers struggle with insurance after disaster. Policyholder efforts to overcome inadequate insurance did not only consist of taking out loans or using savings; rather, individuals actively attempted to minimize the size of their home insurance gaps through actions intended to increase insurance payouts or decrease rebuilding costs. For insured households, gap-minimizing strategies -- which I identify as negotiating, barn raising, and downsizing -- constituted much of the disaster recovery process.