In the aftermath of the 2025 Palisades and Eaton fires, thousands of homeowners learned a terrible fact that compounded their tragedy. Although they had intended to insure themselves sufficiently to rebuild, their coverage was inadequate to the need.
This hidden problem was brilliantly described and analyzed in the series, “Burned,” by Susie Neilson, Megan Fan Munce and Sara DiNatale of the San Francisco Chronicle, for which they earned a Pulitzer Prize. Their series led to a hearing and subsequent report by the California Board of Equalization. As I was researching my policy platform last year to run for California Insurance Commissioner, following these threads led me to Professor Kenneth Klein, law professor at Case Western.
Klein has spent decades studying this issue, becoming America’s preeminent expert on homeowners’ underinsurance. He has described his findings in a 2026 academic paper and a more readable article for the American Bar Association.
Below is my summary of the key points from Klein’s work and a description of the policy options to solve it, along with my thoughts on the path forward.
The Contours of the Problem
According to Klein’s research, approximately 70% of all homes are underinsured by an average of about 20%. These numbers are the average across all fires, whether it’s a wildfire that affects thousands or a single house fire. The cost to rebuild after a wildfire is generally higher because the demand to rebuild overwhelms the supply of available resources, so homes destroyed in a wildfire are underinsured somewhat more often and by a higher amount: 80% and 25%, respectively. But this is a widespread problem, not a wildfire-specific issue, and Professor Klein estimates it has been happening for decades.
Of course nobody wants to pay more than they have to for insurance, but this widespread underinsurance is not caused by customers skimping on coverage. Klein’s research indicates nearly all homeowners intend to fully insure and believe they have done so — even though they have not.
It is also important to emphasize that insurance companies are not trying to underinsure customers. There is a market failure here, which we will describe below. This is not analogous to an insurance company delaying or denying legitimate claims payments, for example. Insurance companies are leaving money on the table by not selling a greater amount of coverage that the customer wants to buy. Why?
The root of the problem is how the insurance company estimates how much coverage the customer needs. Houses are not like automobiles, which have standard models and features. Each house is different, and the cost to rebuild changes for each house in each location differently over time. The reconstruction cost must therefore be estimated on a case-by-case basis. And furthermore, it must be estimated in an amount of time and a degree of intrusiveness the customer will tolerate.
The estimate is generated by gathering a small set of data points (Klein estimates typically fewer than a dozen), and then plugging these data into a software tool that generates a point-of-sale reconstruction cost estimate. While there are alternatives, one software product has a near-monopoly: Xactimate, which is owned by Verisk. (We will come back to the fact of this dominant market share shortly.)
Now, so far this all makes sense. The insurance company needs to generate an estimate. That estimate will naturally be highly imprecise, since customers do not want to go through the painful, time-consuming process needed to generate a more accurate number. That degree of imprecision means there will be fairly wide error to the estimate. But if the estimate were unbiased, the errors would break evenly in both directions. Why is the estimate consistently biased to be too low?
The answer, according to Klein, is the Xactimate software tool is addressing two problems at the same time. It is used to generate both a pre-loss estimate for underwriting, and a post-loss estimate for reconstruction.
When a home is destroyed, the insurance company hires a claims adjuster to estimate the (post-loss) reconstruction cost. This requires analyzing literally thousands of line items using Xactimate. That estimate is then used as the opening bid by the insurance company with the homeowner and their contractor.
Now, here comes Klein’s key insight. If the Xactimate estimate were unbiased, it would cause the insurance company to overpay. Why? Because the opening bid gives the homeowner’s contractor an opportunity to assess and respond using their own private information. Every time the bid was too high, the contractor would recognize that and accept; while every other time the contractor would dig in and negotiate. From a negotiating perspective, in order to avoid overpaying, the insurance company needs Xactimate to generate a reasonable opening bid estimate rather than a reasonable final price estimate.
Professor Klein believes the Xactimate pre-loss underwriting estimate is biased low because the same tool is used to generate a post-loss reconstruction estimate. The insurer’s need for the post-loss opening bid to protect it against overpaying wins over the desire for the pre-loss underwriting estimate to capture the customer’s full coverage need.
Obviously, the insurance companies don’t look good in this story. But in thinking through how to solve this market failure, it’s important to grasp their motivations objectively. Insurers would like to sell full coverage to their customers, who in turn would like to buy it. This market failure exists because the insurers are protecting their downside when negotiating with contractors using the tools available to them within the existing laws.
What is the best way to fix this market failure so customers get the full coverage they want and need when buying homeowners insurance?
In Part Two, we will look at the four policy options:
- Mandate insurance companies offer guaranteed replacement cost
- Increase competition for the reconstruction estimate software tool
- Increase legal liability for insurance companies that sell inadequate coverage
- Mandate insurance companies offer extended replacement cost coverage
Patrick Wolff is a financial analyst, former candidate for California Insurance Commissioner. He lives in San Francisco. This is reprinted with permission. Read his Substack, Wolff’s Den.