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As wildfires grow more destructive, including the multiple fires tearing through Los Angeles County that have destroyed over 2,000 structures and claimed at least five lives, a new study underscores a critical issue that will make recovery harder for many homeowners: underinsurance.

While most people believe they have  to completely replace their house in the event of such a disaster, three-quarters of those who lost their homes in another recent urban wildfire were not fully covered for total losses, according to the , posted to the Social Science Research Network in December 2024.

Tony Cookson

Researchers analyzed data from the Marshall Fire in Colorado, which consumed more than 1,000 homes in suburban ��«����Ƶ County on Dec. 30, 2021. After examining insurance contracts from 24 insurers in the state, specifically focusing on nearly 5,000 policyholders who filed claims after the Marshall Fire, they found that 74% were underinsured. Of those, 36% were classified as severely underinsured, meaning their coverage limits were less than 75% of their home’s actual replacement cost.

“If you're 25% short of being able to rebuild, that's severe,” said Tony Cookson, finance professor in the Leeds School of Business and a co-author of the study. “To put that in context, if it costs $1 million to rebuild, that's $250,000 people have to come up with. Most households don't have ready access to those types of resources.”

Cookson, along with co-authors Emily Gallagher, assistant professor of finance at Leeds, and Philip Mulder, assistant professor in the risk and insurance department at the Wisconsin School of Business at the University of Wisconsin-Madison, found that underinsurance is not caused by homeowners neglecting to update their policies, nor is it solely due to rising rebuilding costs. While higher-income households are less likely to be underinsured, most of them have insufficient coverage as well.

Instead, research suggests insurance companies play a key role in underinsurance. The amount of coverage homeowners receive varies widely depending on the insurer, even for similar properties.

“Which insurance company you go with is pivotal for how much coverage you end up with,” Cookson said. “The wide variation in insurance coverage suggests that there were opportunities for consumers to shop around for better coverage.”

Despite this, many people are not fully aware of how much coverage they need and tend to focus primarily on premiums when making their decisions, he added.

Emily Gallagher

“When consumers focus on premiums rather than coverage limits, insurers have a very natural incentive to cut prices by offering less insurance,” Cookson said.

While the study couldn’t name specific insurers, it found that insurers with more policyholders and a longer history of insuring homes tended to provide better, more comprehensive coverage.

Insurance is a complicated financial product, and many consumers struggle to compare policies accurately, Cookson said. “Insurers could provide quotes with transparent, apples-to-apples comparisons. We could have comparison tools that help mitigate this,” he added.

“It's pretty reasonable that people wouldn't know how much it costs to rebuild a house,” Cookson said. “Most of us aren't construction contractors. So if different insurers offer you different amounts for your total loss limit, it's still really hard to compare these policies.”

Rebuilding delays

The study found that homeowners with inadequate insurance coverage were 25% less likely to apply for rebuilding permits within a year and more likely to sell their properties instead of rebuilding. This delay in recovery has wider consequences, as rebuilding efforts play a crucial role in restoring homes, creating jobs and stimulating local economies.

Cookson explained that after the Marshall Fire, many people who were underinsured tried to hold onto their properties to gather the financial resources needed for rebuilding. “Eighty-three percent of people wanted to rebuild,” Cookson said, “But by now, only about 60% to 70% have actually rebuilt. The gap in rebuilding is significantly explained by how underinsured these people were.”

Looking ahead, the researchers suggest that enhancing consumer awareness and providing clearer information on coverage options could help mitigate this problem. Homeowners, the researchers argue, should be encouraged to compare policies based not just on premiums but on the actual cost per dollar of coverage. This could lead to more informed choices and better disaster recovery outcomes.

“These fires create total losses for individuals and communities. Current disaster assistance tools are limited, with caps often lower than the underinsurance levels,” Cookson said. “With these disasters becoming more frequent, it’s vital for homeowners to be aware of coverage gaps before disaster strikes.”