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Coverage Neglect in Homeowner's Insurance

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  • J Anthony Cookson
  • Emily Gallagher
  • Philip Mulder

Abstract

Most homeowners do not have enough insurance coverage to rebuild their house after a total loss. Using contract-level data from 24 homeowner's insurance companies in Colorado, we show wide differences in average underinsurance across insurers that persist conditional on policyholder characteristics. Underinsurance matters for disaster recovery. Across households that lost homes to a major wildfire, each 10 percentage point increase in underinsurance reduces the likelihood of filing a rebuilding permit within a year of the fire by 4 percentage points. To understand why consumers purchase underinsured policies, we build a discrete choice insurance demand model. The results suggest that policyholders treat insurers that write less coverage as if they set lower premiums, forgoing options to get more coverage at the same premium from other insurers — a pattern we call coverage neglect. Our findings suggest that coverage limits are either not salient to consumers or difficult to estimate without the input of insurance agents. Under a counterfactual without coverage neglect, consumer surplus increases by $290 per year, or 10 percent of annual premiums, on average

Suggested Citation

  • J Anthony Cookson & Emily Gallagher & Philip Mulder, 2025. "Coverage Neglect in Homeowner's Insurance," Working Papers 25-09, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:99690
    DOI: 10.21799/frbp.wp.2025.09
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    More about this item

    Keywords

    Disaster Insurance; Disaster Recovery; Information Frictions and Limited Attention; Insurance Demand;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets
    • G52 - Financial Economics - - Household Finance - - - Insurance
    • G53 - Financial Economics - - Household Finance - - - Financial Literacy
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming
    • R22 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Other Demand

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