Underinsurance

What Is Underinsurance?

Underinsurance refers to an insufficient insurance policy. Although a good insurance policy won’t prevent any of life’s calamities, it should make the financial consequences easier to bear. Underinsurance, however, can leave the enrollee liable for a large financial 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 insurance coverage that leaves the policyholder responsible for a large percentage of a total loss or expense and may lead to financial hardship.
  • If a homeowner is underinsured and there’s significant damage to a residence, 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 homeowner's insurance are rising. Shopping around for competitive bids may save you money.
  • It's important to set aside money to meet health insurance deductibles and copays 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 can be paid out by the insurance policy. A lower-benefits policy may seem attractive because you pay lower monthly insurance premiums. But if the policy leaves you underinsured, the loss arising from a claim may far exceed any marginal savings in insurance 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 on the upswing.  From 2017 to 2021, premiums reportedly rose an average of 12.2% nationwide. Lots of natural catastrophes, coupled with more people moving into disaster-prone regions and rising home repair and rebuilding costs, are considered the main drivers of this rise in insurance costs.

$1,398

The average annual homeowner's 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 that are 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 own resources.

How to avoid residential underinsurance

  • If you experience a sharp rate increase, shop around. You may be able to find a less expensive option that still provides ample coverage.
  • If you want to stay with your current 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 (Fair Access to Insurance Requirement) program, available in many states.

Underinsurance and Health Insurance

The percentage of U.S. adults with no health insurance decreased from 16% in 2010 to an estimated 9.6% in 2021, thanks mainly to the Affordable Care Act (ACA), or Obamacare. 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 they're sick, skipping a test or treatment recommended by a doctor, not seeing a specialist, or not filling a prescription because of the cost.

A person is considered underinsured if their out-of-pocket healthcare expenses are between 5% and 10% of their annual income, or if their health plan deductible is more than 5% of their annual income, according to the Commonwealth Fund. 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 monthly premium levels (which often mean higher deductibles and higher copays) and more comprehensive coverage. This applies to choices in healthcare plans offered by an employer, plans selected at healthcare.gov and medicaid.gov, Medicare Supplemental (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 who experience 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. An analysis by the Kaiser Family Foundation found that 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. A May 2020 Commonwealth Fund study, for example, calculated the 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 copays so that economic considerations won’t keep you from seeking needed care. And make sure the plan has a high upper limit so you are covered for unexpected emergencies.
  • If you are in good health and have received medical care regularly, 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.
  • If possible, 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 basically refers to a person having insurance coverage but with a policy that won’t pay out enough to cover the full 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 a bout 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 decent understanding of how these products work. Insurance, though a relatively simple concept, is often wrapped in complex jargon and pages of fine print, which if not properly read and understood could lead to big discrepancies between what is expected and what is actually offered.

Article Sources
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  1. Swiss Re Group. "Turbulence After Lift-Off: Economic and Insurance Market Outlook 2022/23."

  2. Insurance Information Institute. "Trends and Insights: Drivers of Homeowners’ Insurance Rate Increases."

  3. Insurance Information Institute. "Trends and Insights: Drivers of Homeowners’ Insurance Rate Increases," Page 1.

  4. Insurance Information Institute. "What If I Can't Get Coverage?"

  5. Commonwealth Fund. "U.S. Health Insurance Coverage in 2020: A Looming Crisis in Affordability," Page 3.

  6. Commonwealth Fund. "U.S. Health Insurance Coverage in 2020: A Looming Crisis in Affordability," Page 5.

  7. U.S. Centers for Medicare & Medicaid Services, Healthcare.gov. "The 'Metal' Categories: Bronze, Silver, Gold & Platinum."

  8. National Archives, Federal Register. "Short-Term, Limited-Duration Insurance."

  9. Kaiser Family Foundation. "Understanding Short-Term Limited Duration Health Insurance."

  10. U.S. Centers for Medicare & Medicaid Services, Healthcare.gov. "What Marketplace Health Insurance Plans Cover."

  11. KFF. "Analysis: Most Short-Term Health Plans Don’t Cover Drug Treatment or Prescription Drugs, and None Cover Maternity Care."

  12. Commonwealth Fund. "In the Age of COVID-19, Short-Term Plans Fall Short for Consumers."

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