Coverage Neglect in Homeowners Insurance

Abstract

Most homeowners lack sufficient insurance coverage to fully rebuild their homes after a total loss. Using contract-level data from Colorado, we document substantial variation in underinsurance across insurers that cannot be explained by policyholder characteristics. Instead, insurer attributes, such as local market experience and reputation, predict more complete coverage. These differences affect disaster recovery: among households that lost homes in a major wildfire, those insured by low-coverage firms were less likely to rebuild and more likely to sell. To understand why consumers do not fully insure, we estimate a discrete choice model of insurance demand. The results indicate that many homeowners could obtain greater coverage at no additional cost by switching insurers. This pattern suggests that consumers pay limited attention to differences in quoted coverage limits, a phenomenon we call coverage neglect.  In partial equilibrium, we estimate that coverage neglect reduces consumer surplus by $290 per year—equivalent to about 10% of average annual premiums.

Keywords: Insurance Demand JEL Codes: G22, G41, G52, G53, Q54, R22, Climate Change, Information Frictions, Limited Attention, Natural Disasters, Underinsurance, Coverage Limits, Discrete Choice Models