Understanding Home Insurance and the Risks of Underinsurance
Many homeowners are unaware that their homes might be underinsured, which can lead to significant financial difficulties if something goes wrong. According to Fei Huang, an associate professor at the University of NSW Business School in Sydney/Gadigal, a home is often a person’s largest financial asset, making it crucial to ensure adequate insurance coverage.
A recent survey by the Australia Institute found that 15% of homeowners believe their homes are underinsured. However, many people may not even know whether they are underinsured, says Daniel Graham, an insurance expert with consumer group Choice.
What Does Home ‘Underinsurance’ Mean?
Underinsurance occurs when your insurance policy doesn’t fully cover the cost of rebuilding, repairing, or replacing your home. According to the government’s MoneySmart website, home insurance typically covers damage or loss caused by events such as natural disasters, theft, and accidents. The maximum amount an insurer will pay under a home or home and contents insurance claim — known as the “sum insured” — should not be less than these potential costs.
The Insurance Council of Australia defines underinsurance as when a home insurance policy’s sum insured falls short of what it would actually cost to repair and rebuild a property. Additionally, some policies may include a “coinsurance” or “averaging” clause, which limits the insurer’s liability on claims to the proportion of the replacement value that has been insured.
For example, if you’re only insured for 67% of your home’s value, the insurer might only pay you 67% of the amount you’re insured for if the home is destroyed.
Are More Homes Really Underinsured?
Trends outside the industry are exacerbating the issue of underinsurance, according to the Insurance Council of Australia. Construction costs have risen more than 40% since 2020, meaning some homeowners’ coverage may no longer reflect current rebuild costs.
MoneySmart notes that home and contents underinsurance is very common in Australia and can creep up on you. This is often due to policies not being based on replacement cost, which is the amount it would cost to replace everything new at today’s prices. Instead, policies might reflect an outdated value. Some homeowners may also lack contents insurance or be uninsured for specific scenarios like flood or fire.
Dr. Huang points out that rising premiums and inflation have likely left more people underinsured. She recommends checking insurance costs when buying a home, especially in high-risk areas.
How to Determine if You Have the Right Amount of Cover
The Insurance Council of Australia advises reviewing the amount your home is insured for annually and after any renovations. Use your insurer’s online rebuild calculator, ensure your policy accounts for demolition, professional fees, and current building code compliance, and consult your insurer or broker if you have any doubts.
When calculating contents insurance, Mr. Graham suggests going from room to room, listing items. Substantial items include furniture and appliances, but smaller things like clothing can add up. He recommends reassessing your home and contents insurance at least every few years, ideally when your renewal notice arrives. Remember to consider any renovations or additions, such as installing air conditioning.
Mr. Graham and Dr. Huang both recommend using the online calculator tools insurers provide. “It’s definitely worth having a look at those, but also think about your own possessions and property and how much it might cost to replace them,” Mr. Graham says.
The Risks of Underinsurance
The biggest risk of underinsurance is experiencing a total loss and needing to rebuild. In this case, the insurer might offer a cash settlement instead of covering the full cost. You could be left organizing construction and facing substantial out-of-pocket expenses. This might force you to reduce the size or standard of your home or sell the land and buy in a more affordable area.
While some might think underinsurance offers cheaper premiums, Mr. Graham and Dr. Huang don’t see it as worth the risk. Dr. Huang explains that unless you’re very wealthy, you probably cannot absorb the losses that home insurance protects against. As Mr. Graham puts it, “It really goes against the point of the product.” There are better ways to get a lower home insurance premium.
How to Shop Around for the Right Policy
When your renewal notice arrives, Mr. Graham recommends spending an hour or two getting quotes from different providers on a weekend. Aim for at least four or five quotes, and use an independent comparison website to help. There is a wide range of insurance prices, and there are ways to lower your premium.
Increasing your excess — the amount you pay out of pocket when you make a claim — can significantly reduce your premium, he says. “If you take the time to shop around, in most cases you will be able to end up with a better deal.”
Dr. Huang agrees, stating that comparing quotes and swapping between providers will help you get a lower premium in the Australian market. If you’re struggling to get insurance, talking to an insurance broker could be worthwhile.
This article contains general information only. You should consider obtaining independent professional advice in relation to your particular circumstances.
