Actionable data plays an essential role as policyholders choosethe right amount of coverage to protect their homes in the event ofa disaster. In today's tumultuous housing market, current, reliableinformation is more invaluable than ever as property insurers workto alert policyholders to changing variables that could increasethe likelihood that their properties are underinsured.

Certainly underinsurance is no new problem in the propertyinsurance industry. In past years, insurers frequently encountereddifficulties creating replacement-cost estimates that adequatelyaddressed properties' probabilistic risk. Only within the pastdecade have we been able to harness the power of enormous amountsof data containing construction rates and detailed structuralinformation for millions of U.S. properties. Advances in analyticaltools also enable us to drill down to specific zip codes so we canview local trends for common building materials and labor necessaryto rebuild a structure. Thanks to these tools, we are now able tocreate a component-based estimate for a building that is based oncosts being paid for actual claims in the area and supported bydetailed construction market research.

Despite all the advances we've made in technology, the homevaluation process is still fraught with challenges. Recent trendsin the housing market and construction industry have increased manyproperties' exposure to underinsurance, as some policyholders havereduced their insurance coverage to cope with the economicrecession. This creates a precarious situation because affectedpolicyholders could end up shouldering more risk if their propertyis destroyed in a disaster. Reconstruction cost data and analyticaltools are invaluable resources that can help mitigate these issues.They provide policyholders with in-depth information aboutpotential risks and with reliable insurance-to-value estimates thathelp them protect their investments.

Declining Home Market Values

Home market values have been on a steady decline ever since thehousing bubble burst three years ago. The National Association ofRealtors reports that the U.S. median sales price for asingle-family home was $172,900 at the end of 2009, a 20.6-percentdecrease from the median sales price of third quarter 2007. Manyregions across the U.S. have suffered substantial losses since thefourth quarter of 2008. Ocala, Fla. experienced the steepestdecline of 23.4 percent, followed by Las Vegas, N.V. with a declineof 23.3 percent. As houses across the nation continue to losevalue, another trend is unfolding in the construction industry thatputs many policyholders at increased risk of being underinsured,should disaster strike.

Rising Reconstruction Costs

While the value at which a home can be bought or sold implodedduring the past three years, the cost to rebuild that same homewith like-kind-and-quality materials has continued to increase.Analysis of thousands of field surveys and millions of actual claimfiles and construction rates in all 50 states and the District ofColumbia reveals that nationwide reconstruction costs increased0.96 percent in 2009. As shown in below in Figure1, Vermont, Arkansas, Texas, Oklahoma, and North Carolinaexperienced the highest increases in the overall cost to rebuild.Only Florida and Rhode Island reported decreases in reconstructioncosts.

This growth appears anemic when compared to a 3.95-percentincrease in 2008 and a 4.18-percent increase in 2007, but researchshows that reconstruction costs jumped 16.22 percent since thehousing market first began to plummet. Figure 2illustrates the tremendous disproportion that currently existsbetween the U.S. median sales price and reconstruction costs. Thisresearch also demonstrates the amount of probabilistic risk manypolicyholders now face, especially the high number of homeownerswho have opted to buy less insurance to cut expenses.

Reducing Coverage in Tough Times

As the current financial crisis deepened in 2009, a high numberof homeowners reduced their insurance coverage in a bid to savemoney. A recent study by the Insurance Information Institute,titled "January 2010 Insurance Pulse," found that 22 percent ofsurveyed homeowners admitted to buying less insurance last year.This is a particularly alarming statistic, considering the recentstring of international disasters that have re-emphasized theimportance of having adequate insurance coverage. The high numberof people cutting back on insurance is also indicative ofwidespread misconceptions about how insurers calculatecoverage.

Separating Fact from Fable

Property insurance professionals know the implications whenreconstruction costs outstrip market value, but many propertyowners and commentators don't understand the distinction. Salesprice is at the forefront of their minds, so it seems reasonable tothem that the monthly premiums covering a home would drop inproportion to a decrease in market value. Some even see this as anideal time to barter for lower insurance rates. For example, arecent edition of a leading consumer magazine contained a briefarticle advising homeowners to renegotiate their annual policycosts based on the value their homes have lost during the housingslump.

This ill-advised tip appears reasonable to many policyholders,but it's akin to assuming the cost to repair a car decreased justbecause the buyer negotiated a good price from a dealer with anoverstocked inventory. In the same way, the current housing turmoilhas driven down property values across the nation, and many banksand lenders have slashed prices just to sell homes and minimizetheir losses.

Under normal circumstances (an upward-trending economy), themarket value of a property, including the land, is generally higherthan the cost to reconstruct just the building. But market valueand reconstruction costs are not tightly linked, and they do nothave to move at the same speed or even in the same directionbecause they are affected by different factors. Reconstructioncosts are influenced by the supply and demand of building materialsand labor, while market value is influenced by the supply anddemand of completed homes. In the current economy, land values andhome values in some areas have deteriorated much more thanconstruction costs. As a result, some homes' reconstruction costsare higher than their market value.

The following example provides a useful illustration: afour-bedroom, two-bath, 1,980-square-foot one-story home inMontpelier, Vt., is currently on sale for $224,000. According to anonline replacement-cost estimator, however, it could cost as muchas $323,400 to rebuild the structure. A homebuyer who decides toinsure the structure at its sales price would have to pay as muchas $99,000 out of his or her own pocket to rebuild, should a fireor storm destroy the structure.

While this example is not typical in every area of the U.S., itis certainly possible in areas that have experienced the greatestamount of market value depreciation. Reliable information found incomprehensive databases and analytical tools not only aidsprofessionals who help policyholders choose the best coverage fortheir homes, but is also useful in promoting understanding aboutthe valuation process and how insurers estimate replacementcosts.

Raising Awareness about Risks

As the adage goes, knowledge is power. Policyholders whounderstand the variables that affect their properties'reconstruction costs and the risks they face are in a betterposition to select the appropriate amount of coverage necessary toprotect their homes. Some insurance organizations recognize thesebenefits, and they are expanding efforts to promote awareness aboutthese issues. For example, the Insurance Bureau of Canada hasembarked on a public awareness campaign, using Web sites,brochures, and support materials to educate consumers aboutunderinsurance risks and how insurers calculate replacement costs.Thoroughly researched and comprehensive cost data and high-poweredanalytics can also play an important role in efforts to alertpolicyholders to the dangers of underinsurance.

Current technology gives underwriters and claim professionalsthe ability to access localized, up-to-date cost information forlabor and materials as well as analytical tools that track criticaltrends in the construction and insurance industries. These providevaluable resources to explain the difference between market valueand reconstruction costs and show policyholders the appropriateamount of coverage their properties need. This also increasestransparency because policyholders can view detailedcomponent-based estimates -- in other words, where each stick oflumber, gallon of paint, or hour of labor is accounted for indetail -- to ensure they are protected against any unforeseenrisks.

It is uncertain when the housing market will rebound. Theeconomy has lost significant ground, and it may take several yearsof sustained growth before a recovery takes place. It is reasonableto assume the market must correct in those areas where home valuesare currently less than reconstruction costs -- whether it be anincrease in market values, a decrease in construction costs, orsome combination of the two -- before the construction industrybegins to produce more inventory. Experts predict this will taketime.

For instance, financial service provider Fiserv recently issueda report stating it expects home sales prices will continue todecline until the end of 2010 before they start to rise. Fiservalso expects that sales prices in areas most affected by thehousing crisis (such as metropolitan areas in California, Florida,Arizona, and Nevada) may not return to peak levels until 2025.

Regardless of what happens in the housing market, there are anumber of tools and strategies available as underwriters and claimprofessionals work to promote awareness about underinsurance risksand help policyholders select the right amount of coverage to givethem peace of mind, knowing they have adequate protection if theday comes when they will need it most.