Underinsurance: What it is, How it Works, FAQ

What Is Underinsurance?

Underinsurance refers to insufficient insurance. A good policy won’t prevent life’s calamities, but it should make the financial consequences easier to bear. However, underinsurance can leave the enrollee liable for a large expense if a serious event occurs. Whether it’s a home damaged by a hurricane or fire, or an insured person experiencing a serious disease or accident, insurance should ideally cover enough of the expense that the policyholder can manage the difference.

Key Takeaways:

• Underinsurance is insufficient coverage that leaves the policyholder responsible for a large percentage of a loss or expense and may lead to financial hardship.
• If a homeowner is underinsured and the residence suffers significant damage, then the insurance payout may not be enough to cover repairs or replacement.
• Similarly, inadequate health insurance coverage can lead to medical debt and even bankruptcy if a serious illness or accident occurs.
• Rates for homeowners insurance are rising. Shopping around for competitive bids may save you money.
• Set aside money to meet health insurance deductibles and co-pays so that needed care isn’t delayed for financial reasons.

What Happens When You’re Underinsured

You can be underinsured if your policy has gaps or exclusions that leave you without coverage. Or it could be that your claim exceeds the maximum amount that the insurance policy can pay out. A lower-benefits policy may seem attractive because you pay lower monthly premiums. But if the policy leaves you underinsured, then the loss arising from a claim may far exceed any savings in premiums.

Underinsurance can cause a serious financial crisis, depending on the asset that is insured and the extent of the shortfall in insurance.

Inflation, extreme weather events, and an increase in people’s risk consciousness due to the COVID-19 pandemic will trigger above-average insurance premium growth in 2022, according to global insurance provider Swiss Re Group.

Underinsurance and Residential Insurance

Insurance costs for home and rental properties are rising. From 2017 to 2021, premiums reportedly rose an average of 12.2% nationwide. Natural catastrophes, more people moving into disaster-prone regions, and rising home repair and rebuilding costs drive this rise in insurance costs.

$1,398

The average annual homeowners insurance premium in 2021

Underinsurance for your home can cause a serious financial crisis, depending on the amount of damage and the extent of the shortfall in insurance. Take, for example, a house and its contents insured against all risks for $250,000 with a deductible of $20,000. The house is subsequently destroyed in a fire, and the cost to replace the residence and its contents comes to $350,000. That will require the homeowners to make up the difference of $100,000—plus the $20,000 deductible—from their resources.

How to Avoid Residential Underinsurance

• If you experience a sharp rate increase, shop around. You may find a less expensive option that still provides ample coverage.
• If you want to stay with your insurer, ask for a quote for a policy with a higher deductible that maintains good coverage. A higher deductible should mean lower premiums and may be worth it if the reduction is significant.
• Check the policy’s exclusions. Damage from earthquakes and floods, for example, is usually not included.

If you can’t purchase a policy because you live in a high-risk area, consider buying one through a Fair Access to Insurance Requirements (FAIR) program, available in many states.

Underinsurance and Health Insurance

The percentage of U.S. adults with no health insurance decreased from 20% in 2010 to an estimated 13% in 2020, thanks mainly to the Affordable Care Act (ACA). However, the percentage of adults who are underinsured increased from 16% in 2010 to 21% in 2020.

When individuals and families are underinsured, they may have to take on debt to pay deductibles and medical bills. They may postpone needed care—avoiding seeing a doctor when sick, skipping tests or treatments, not seeing a specialist, or not filling prescriptions due to cost.

A person is considered underinsured if their out-of-pocket healthcare expenses are equal to or exceed 10% of their annual income (5% if low-income), or if their health plan deductible is more than 5% of their annual income, according to The Commonwealth Fund. About one-quarter of Americans with employer-sponsored health insurance were underinsured in 2020.

Choosing a health insurance plan often involves striking a balance between lower premium levels (which often mean higher deductibles and co-pays) and more comprehensive coverage. This applies to choices in healthcare plans offered by an employer, plans selected at HealthCare.gov and Medicaid.gov, Medicare Supplement (Medigap) policies, and Medicare Part D prescription drug coverage.

In a lower-premium bronze plan at HealthCare.gov, for example, you are responsible for 40% of your covered healthcare costs, and the insurer pays about 60%. In the highest-premium platinum plans, you pay 10% and the insurer pays 90% of your covered healthcare costs.

Short-Term Health Plans and Underinsurance

Short-term health plans were traditionally marketed to people experiencing temporary gaps in coverage. These plans are less costly than the lowest level plans at HealthCare.gov and can deny or restrict coverage for preexisting conditions. In 2017, the Trump administration changed the regulations so that anyone can sign up for a short-term plan and expanded the length of time these plans could be renewed.

Short-term health plans are not required to cover the package of 10 essential health benefits found in the ACA. Many of these plans don’t cover maternity care or, in many cases, substance abuse treatment, outpatient prescription drugs, or mental health services.

People in short-term healthcare plans are more likely to have coverage gaps. When services are covered, cost sharing may be very high. For example, a May 2020 study by The Commonwealth Fund calculated out-of-pocket costs for COVID-19 patients who had short-term plans in Georgia, Louisiana, and Ohio. For patients with a moderate case of the virus, patient costs ranged from $14,600 to $17,750. For a severe case of COVID, patient costs ranged from $28,600 to $35,000.

How to Avoid Health Underinsurance

• Set money aside to meet deductibles and co-pays so that economic considerations won’t keep you from seeking needed care. And make sure the plan has a high upper limit so that you are covered for unexpected emergencies.
• If you are in good health and have received regular medical care, you may be able to save money by choosing a low-premium, high-deductible plan.
• If you have a chronic health condition or have not had regular medical care, it’s best to opt for a plan with higher coverage.
• When choosing among employer-based health insurance plans, be aware that some may leave you underinsured. Look for the most comprehensive plan you can afford.
• Avoid short-term health insurance plans, as they can leave you underinsured. They are not mandated to cover all essential health services and may have high deductibles and cost sharing.

What is meant by underinsurance?

Underinsurance refers to having coverage that won’t pay out enough to cover the expenses incurred when filing a claim. For example, if Roy has his house insured for $200,000, but the cost to repair it in the event of bad weather would be at least $300,000, then he is underinsured—in this case, by $100,000.

How many Americans are underinsured?

According to The Commonwealth Fund, 21% of U.S. adults had inadequate health insurance coverage in 2020.

Who is most likely to be underinsured?

People most likely to be underinsured include those struggling to make ends meet and those without a good understanding of how these products work. Insurance, though a relatively simple concept, is often wrapped in complex jargon and fine print. If not properly understood, this could lead to big discrepancies between expectations and reality.