Climate Change Exposes a Major Home Insurance Gap

A year after the Los Angeles wildfires, many survivors face the same problem: Their insurance policies aren’t paying out enough to cover the cost of rebuilding.

It’s a tragic predicament. And it will happen again when the next disaster hits.

Since the 1990s, American homes have been systematically underinsured in the event that they are completely destroyed. Study after study shows that, counter to the public’s understanding, many home insurance policies are not required to cover total replacement of homes.

The trend, though decades old, has been somewhat hidden. But climate-driven events that cause massive destruction, especially wildfires, are revealing just how pervasive and severe the problem has become.

“Climate change did not cause underinsurance, but it does expose it and amplify it,” said Kenneth Klein, a professor at the California Western School of Law specializing in the topic.

Global warming is creating a hotter and drier world. Combined with more construction in areas with lots of flammable vegetation — the wildland-urban interface — it’s led to a rise in damaging fires in the US. Researchers at the University of Colorado Boulder in 2023 found that wildfires in Western states destroyed 243% more buildings in the decade between 2010 and 2020 than in the previous decade. The fires in LA claimed in excess of 15,000 structures.

United Policyholders, an advocacy group, was formed in part to help homeowners not being adequately covered for rebuilding costs after the Oakland firestorm of 1991. The group began sending surveys to wildfire survivors in 2007, and since then, an average of two-thirds of respondents said they had found themselves underinsured, by an average amount of $200,000 or more.

Acute demand for labor and materials can send prices soaring after a disaster, and it’s hard for the insurance industry to know before an event occurs how much costs will go up.

That wouldn’t have been a problem before the 1990s, according to Klein, because until then most US home insurance policies included a guaranteed clause to replace no matter the cost. But as American houses got bigger and more expensive, the guarantee lost ground to replacement-cost-value coverage, which sets an upper limit on how much the insurance company will pay out.

Most major insurers use third-party estimator tools to determine the upper limit. Consumer advocates and plaintiffs’ attorneys have charged that such tools routinely underestimate rebuilding costs, which in turn helps insurers keep premiums low and sales strong on the front end.

“If any state legislature were to pass a law” that made it the insurer’s responsibility to fully restore a fire-damaged home, said United Policyholders Executive Director Amy Bach, “the problem would be solved because to avoid litigation liability, insurers would figure out how to get it right.”

A disaster-recovery reform bill recently introduced in the California state senate would require insurance companies to at least offer guaranteed replacement cost policies.

Colorado Insurance Commissioner Michael Conway said his state considered a similar measure but decided “it would destroy our market.” Most big insurers don’t even write guaranteed replacement cost policies anymore, he said, and aren’t interested in doing so, at least for Colorado customers.

Conway has other ideas for how to cut rates, for example, by getting insurance companies to credit homeowners for steps taken to reduce their risk of wildfire. In the meantime, he worries, “the next big hailstorm, we are going to see a wave of underinsurance there, too.” Read more