Underinsurance: What it Is and How it Leaves You Unprotected

Being underinsured can hit you where it hurts the most—your pocket. Underinsurance leaves you wide open for financial ruin if a major disaster hits. Whether for your home, automobile, life, health, or business, having adequate insurance can save you in the long run.

Not convinced? In this two-part series, we’ll take a look at:

Part 1: The meaning of being underinsured and how it affects your home, automobile, business, and your family’s financial security if you pass away.

Part 2: How you can review your policies for gaps, boost your financial security coverage, and avoid underinsurance.

I’ll break down some risks based on the different types of policies. But first, what does the term underinsurance mean?

I | What is Underinsurance?

Underinsurance refers to insufficient insurance coverage that does not offer you adequate protection. No matter the type of insurance you purchase, you are underinsured if there are massive gaps in the damages covered.

Insurance policies will not prevent catastrophic events, nor will they remove all of your financial obligations. The best insurance policy shields you from bearing all of the financial burdens of a disaster. Whether it be losing your home to a flood or tornado, losing your car in a fire, meeting in a severe automobile accident, or experiencing a severe illness.

You won’t be able to predict when the unthinkable might occur. If you’re underinsured, expect to cover most of the expenses on your own. In a worst-case scenario, say a liability lawsuit filed by a disgruntled client or employee or high medical costs, accumulated debt may lead to bankruptcy.

II | Reasons Why You May Be Underinsured

Though all insurance policies (home, auto, business, life, etc.) are different, there are some general reasons why you may be underinsured. In some cases, you might not be aware of the risks, while in others, it’s a matter of not being proactive with safeguarding your assets.

1. Your agent does not have your best interest at heart.

Not all insurance agents or brokers are in your corner. Some pay more attention to selling policies that will grant them higher commissions than helping clients tailor the best package for personalized benefits. These are the types of agents who tarnish the insurance industry’s reputation and leave you at a considerable disadvantage.

As much as possible, research an agent before signing any papers. Check your social circles for recommendations and only work with agents from reputable insurers. Independent agents are also an option, but they come with additional risks and require thorough vetting.

In the initial meeting, ask all the questions you need to understand your policy’s features. If an agent rushes or pressures you in any way, leave. An agent/broker is your financial partner, and the hope is for a longstanding working relationship.

2. You’re more concerned about the short-term pains than the long-term gains.

Premiums often frighten prospective clients from signing up. Some may set high deductibles (the money you pay out of pocket before your policy kicks in) to cut their monthly insurance premiums. It’s not so much they made the wrong choice, but rather, they did it for the wrong reasons—short-term savings.

Suppose you have a $10,000 homeowners insurance policy with a $5000 deductible. You’ll have to find the first $5000 before your insurer settles the remainder. Therefore, if the total cost for the damages to your home is $4000, your deductible completely covers the cost. You won’t qualify for the company’s portion.

When deciding on the deductible, weigh how much you can manage upfront for damages. Paying for insufficient coverage wastes your money as it won’t give you a high return on your investment.

3. You didn’t do the pre-work necessary before purchasing your insurance.

Insurance policies safeguard your interest. But first, you must know what interests you want to secure. The evaluation process differs depending on the type of insurance you wish to purchase. Let’s look at some examples.

Business Insurance: There are seven types of business insurance available. The level of insurance you require depends on your business size, operations, and commercial properties owned. Write a detailed description of everything related to your business. You can tailor your policy for optimal coverage and track all your commercial assets in one convenient document.

Home Insurance: Create a home inventory list of your assets. Estimate how much it would cost to replace your belongings and the physical structure of your home.

Life Insurance: Consider your current financial responsibilities and how much your family would need to stay afloat in your absence.

4. You’ve tossed your policy on the back burner.

Your policy is not a one-time-never-think-about-it-again arrangement. Revamping your policies after significant life changes like a home or family expansion ensures your policy grows with you.

Set aside time every six months to evaluate your policy and ask, “Does my policy protect my current lifestyle?” If the policy falls short, make the necessary coverage expansions.

Likewise, if you’ve since downsized your business, become divorced, or your home lost significant value, you can save money on premiums. Being overinsured can also become a problem.

III | The Risks of Being Underinsured

The repercussions of underinsurance vary depending on the type of insurance in question. But overall, the financial impact becomes the dominant issue.

Let’s break it all down further, taking a look at policy-specific risks you may face.

What happens if your home is underinsured

Building a dream home is on most of our bucket lists. But what about protecting it? Not in the sense of security systems, though they play a crucial role in lowering your premiums.

We’re talking about disaster protection—events out of your control or those you may unknowingly cause.

1. Your claim won’t cover much.

Suppose you’re underinsured and your home suffers damages for which you need to file a claim. In that case, the compensation you receive may not be enough. Replacing broken windows costs hundreds; replacing a roof can reach the thousands.

Should you lose your home and it costs $300,000 to rebuild, but you insured it for only $150,000, wanting to save money, you’ll have a problem.

Your problem becomes worse with the fact that the $300,000 only covers the physical structure. What about the contents of your home? Your appliances and valuables you lost?

For most Americans, buying a house is their most significant investment. Your home insurance offers protection against the risks your home faces.

2. It affects your chances of qualifying for a mortgage.

As part of your mortgage approval process, your lender will require that you purchase enough homeowners insurance to rebuild your home. Lenders want the assurance that no matter what, they’ll recoup their due repayment.

If you’re considering trimming off a bit from your home policy in the name of saving, you’re out of luck. Mortgage companies often outline the scope of coverage mandatory for loan approval. For example, if you live in a high-risk flood zone, you may be required to purchase flood insurance on top of your regular home insurance. The same applies if you live in an earthquake or wildfire-prone area.

What happens if you’re an underinsured driver

If you opt for bare-bones insurance coverage, you’re leaving a substantial monetary gap. Minimum coverage offers minimum protection.

State-required liability offers compensation for third parties affected if you cause an accident.

It covers their vehicle, property, and medical bills. You’ll have to pay the rest out-of-pocket if your minimum car insurance can’t compensate affected third parties.

On top of third-party damages, you then have to consider your losses. Most of which state-required liability insurance does not cover.

What happens if your business is underinsured

Owning a business is risky, especially if you provide your customers with physical products like food or skincare products. If a customer suffers from an allergic reaction, chances are high that you’ll be liable for the health fees incurred.

1. You could lose your business if you end up in a legal tussle with an unhappy client.

Small businesses lack the advantage of a “big business budget.” As a small business owner, a single lawsuit could put you out of business in one go. Securing your interest with business insurance safeguards your dreams and finances.

2. Prolonged disruption in business operations can cost you.

Business interruption insurance protects you if unforeseen circumstances lead to the temporary shutdown of your business.

Protections offered include lost income and ongoing expenses like the cost of temporary relocation. The property coverage in your business owner’s policy will help repair or rebuild if a flood or fire leads to disruption.

3. The dangers have gone digital.

Adequate cyber liability insurance protects you against damages resulting from data breaches and cyberattacks. We live in a digital age. The risks and occurrences of hackers breaching the digital walls of companies, large and small, are on the rise.

These breaches lead to the theft of client information and confidential data. As the gatekeeper for your client’s data, you’re responsible for its protection. Should an attack occur, however, cyber liability covers claims and expenses arising from the data breach.

Commercial insurance options are customizable, as with all other policies.

4. You’re responsible for the safety of your employees.

As an employer, you’re responsible for the safety of those in your employ. Employee work-related injury is a crucial consideration.

If your workers have to operate equipment or travel for work, calculate the hazards into your coverage. Most states provide legal guidelines for individual workers’ compensation insurance requirements. Negligence on your part can lead to hefty lawsuits and fines.

What happens if you have inadequate life insurance

Your life insurance policy should cover your family’s basic needs in your absence. Consider your accumulated household income and the percentage you contribute to bills, mortgage, groceries, and other necessities.

How much of a gap is your lost income going to leave behind?

Sufficient insurance coverage will act as an income replacement. Even if it doesn’t last the rest of your family members’ lives, it should tie them over until they figure out new arrangements for additional incomes. It could also be your life policy removes some of the financial strains of debts and loans, gifting your loved ones a fresh start. The money they save on paying off these debts and funeral expenses will serve them well.