What happens if your house is underinsured?
Home insurance is often treated as a set-and-forget household bill. But experts warn that many home owners don’t actually know whether the amount they’ve insured their home for would cover the real cost of rebuilding or replacing it after a major event.
Underinsurance can be financially devastating. As Fei Huang, an associate professor in the School of Risk and Actuarial Studies at the University of NSW Business School in Sydney/Gadigal, notes, a home is often someone’s biggest financial asset. If the cover is too low and something goes wrong, the resulting gap can cause serious financial distress.
Home underinsurance is not a niche problem. In an Australia Institute poll conducted last year, 15 per cent of surveyed home owners said their home was underinsured. Yet even that figure may not capture the full picture, because many people may not be able to accurately say whether they are underinsured at all.
Daniel Graham, an insurance expert with consumer group Choice, says that uncertainty is common. Many households may only discover the consequences of underinsurance at the worst possible time: when they need to make a claim after a major loss.
What “underinsured” means in practical terms
If your home is underinsured, it means your insurance policy won’t fully cover the cost of rebuilding, repairing or replacing it. That definition is reflected in guidance from the government’s MoneySmart website.
Home insurance generally covers damage or loss caused by events such as natural disasters, theft and accidents. The key question is whether the maximum amount your insurer will pay under a claim—often described as the “sum insured”—is high enough to meet those potential costs.
The Insurance Council of Australia describes underinsurance as occurring when a home insurance policy’s sum insured falls short of what it would actually cost to repair and rebuild a property. In other words, the policy may exist, and premiums may be paid, but the cover may be insufficient for a full recovery after a serious incident.
Why people become underinsured without realising
Underinsurance can develop quietly over time. MoneySmart says home and contents underinsurance is “very common” in Australia and “can creep up on you”. One reason is that the insured amount can be based on an outdated value rather than what it would cost today.
Graham says underinsurance is mostly caused by home and contents not being insured at replacement cost. Replacement cost is the amount it would cost to replace everything new at today’s price. If a policy is based on older estimates, or if a household hasn’t updated their details after changes to the property or possessions, the sum insured may no longer reflect reality.
There are also cases where people have home insurance but no contents insurance, or where they are uninsured for specific scenarios such as flood or fire. These gaps may not be obvious until a claim is made and the policy wording is tested against what actually happened.
Dr Huang also points to broader economic pressures. Rising premiums and inflation have likely left more people underinsured, particularly if households respond to higher costs by reducing cover or failing to update their insured amounts.
Construction costs and the widening rebuild gap
One of the major forces pushing households into underinsurance is the rising cost of construction. The Insurance Council of Australia says the underinsurance problem is being worsened by trends outside the insurance industry, including the fact that construction costs have risen more than 40 per cent since 2020.
That increase matters because a policy that was adequate a few years ago may no longer reflect current rebuild costs. Even if a home owner has not changed their property, the cost to rebuild it may have changed significantly.
This is one reason annual reviews are often recommended. Without regular updates, the sum insured can lag behind real-world costs, leaving a household exposed to a shortfall if they need to rebuild.
How coinsurance or “averaging” clauses can reduce payouts
Even when a policy has a stated sum insured, the final payout can be influenced by specific policy clauses. MoneySmart notes that a “coinsurance” or “averaging” clause can affect how much an insurer will pay if you are underinsured.
These clauses limit the insurer’s liability on claims to the proportion of the replacement value that has been insured. The effect can be confronting for policy holders who assume they will receive the full sum insured.
MoneySmart provides an example: if you’re only insured for 67 per cent of your home’s value—meaning you are underinsured by 33 per cent—the insurer might only pay you 67 per cent of the amount you are insured for if the home was destroyed. This illustrates how underinsurance can compound the financial hit, particularly in total-loss scenarios.
What can happen after a major loss
The biggest risk, Graham says, is experiencing a total loss and needing to rebuild. In that situation, the insurer may say the amount you insured your building for isn’t enough to replace everything new and may offer a cash settlement instead.
A cash settlement can shift the burden back onto the policy holder. You may be left organising construction, and you may be left substantially out of pocket if the settlement does not cover the true rebuild cost.
Dr Huang says that if an underinsured home is destroyed, owners will likely have to rebuild to a lower standard. That may mean reducing the size of the home, choosing cheaper materials and finishes, or making other compromises that permanently change what the household can afford to rebuild.
Graham adds that in some cases, the financial gap may force difficult decisions, such as reducing the size or standard of the home or selling the land and buying in a more affordable area.
Is underinsuring ever “worth it” to save on premiums?
With home insurance premiums continuing to rise—and with properties in natural disaster-prone areas paying the most—some households may wonder whether there is an advantage to choosing a lower sum insured to reduce premiums.
Both Graham and Dr Huang do not think it is worth the risk. Dr Huang says that unless you are very wealthy, you probably cannot absorb the kinds of losses home insurance is designed to protect against.
Graham’s view is blunt: underinsuring “really goes against the point of the product”. The purpose of insurance is to protect against large losses that would otherwise be unaffordable; reducing cover to the point where a household cannot recover after a disaster undermines that purpose.
How to reduce premium pressure without leaving yourself exposed
While underinsuring may look like a quick way to lower costs, Graham says there are better ways to get a lower home insurance premium.
One practical lever is the excess—the amount you pay out of pocket when you make a claim. Graham says increasing your excess can bring a substantial premium down to something more reasonable. This approach may help manage premium costs while keeping the sum insured aligned with replacement costs.
Another approach is shopping around. Graham recommends that when your renewal notice arrives, you spend an hour or two getting quotes from different providers, perhaps on a weekend when you have time to compare properly.
He suggests aiming for at least four or five quotes, and says using an independent comparison website can help. He also notes there is a huge range in insurance prices, and that taking the time to shop around can often lead to a better deal.
Dr Huang agrees that comparing quotes and swapping between providers can help people get a lower premium in the Australian market.
How often should you review your sum insured?
The Insurance Council of Australia recommends reviewing the amount your home is insured for annually and always after renovations. Renovations and upgrades can change rebuild costs and should be reflected in your policy.
Graham suggests reassessing home and contents insurance at least every few years, but ideally when your renewal notice arrives. Reviewing at renewal can be a natural checkpoint, because it is when many households are already thinking about price changes and whether their cover still suits them.
It is also important to consider additions and improvements, such as installing air conditioning. Changes like these can increase replacement costs and should be factored into the insured amount.
Tools and methods to estimate rebuild and contents costs
Estimating the right sum insured can feel complex, but there are practical ways to approach it. The Insurance Council of Australia recommends using your insurer’s online rebuild calculator and ensuring your policy accounts for demolition, professional fees, and current building code compliance.
If you have any doubt, the council recommends speaking to your insurer or broker. The aim is to ensure that the sum insured reflects the full cost of rebuilding, not just the visible construction component.
For contents insurance, Graham says a basic method is to go from room to room and list items. This includes substantial items such as furniture and appliances, but also smaller things that add up over time, such as clothing.
Both Graham and Dr Huang recommend using the online calculator tools insurers provide. Graham says these tools are “definitely worth having a look at”, but he also encourages people to think carefully about their own possessions and property and how much it might cost to replace them.
What to check when buying a home
Insurance affordability can also matter before you even move in. When you’re looking to buy a home, Dr Huang recommends checking insurance costs as part of the decision. She notes that insurance might be a significant expense in high-risk areas.
Factoring insurance costs into a purchase decision can help avoid future budget stress and reduce the temptation to cut cover later in order to manage rising premiums.
When an insurance broker may help
For some households, getting appropriate cover can be challenging. If you’re struggling to get insurance, Graham says it could be worth talking to an insurance broker.
A broker may be able to help navigate options and clarify how different policies treat key risks and claims scenarios, particularly for people who find it difficult to compare policy details on their own.
Key takeaways for avoiding underinsurance
Know your “sum insured” and whether it reflects today’s rebuild and replacement costs, not an outdated figure.
Review your cover annually and after renovations, as recommended by the Insurance Council of Australia.
Use insurer rebuild calculators and ensure your estimate includes demolition, professional fees, and current building code compliance.
For contents, do a room-by-room inventory so smaller items aren’t overlooked.
Be aware of coinsurance or “averaging” clauses that may reduce payouts if you are underinsured.
If premiums are rising, consider shopping around for quotes and adjusting the excess rather than cutting the sum insured.
A final note
This article contains general information only. You should consider obtaining independent professional advice in relation to your particular circumstances.