Coverage Neglect in Homeowners Insurance

Most homeowners do not have enough insurance coverage to rebuild their house after a total loss. Using contract-level data from 24 homeowners insurance companies in Colorado, we show wide differences in average underinsurance across insurers that persist conditional on policyholder characteristics. Underinsurance matters for disaster recovery. Across households that lost homes to a major wildfire, each 10 p.p. increase in underinsurance reduces the likelihood of filing a rebuilding permit within a year by 4 p.p.. To understand why consumers purchase underinsured policies, we build a discrete choice insurance demand model. The results suggest that policyholders treat insurers that write less coverage as if they set lower premiums, forgoing options to get more coverage at the same premium from other insurers – a pattern we call coverage neglect. Our findings suggest that coverage limits are either not salient to consumers or they are difficult to estimate without the input of insurance agents. Under a counterfactual without coverage neglect, consumer surplus increases by $290 per year, or 10% of annual premiums, on average.