What does "underinsurance" refer to in an insurance policy?

Underinsurance refers to having insufficient coverage for the value of the insured property. This means that the policyholder has selected coverage limits that do not fully reflect the true value of the property they are insuring. In the event of a claim, this can lead to significant financial losses, as the insurance payout may not cover the full extent of the damages or losses incurred.

For example, if a homeowner insures their property for $200,000 while its actual replacement cost is $300,000, they are underinsured. If a fire causes $250,000 worth of damage, the insurance may only cover up to the policy limit of $200,000, leaving the homeowner responsible for the remaining $50,000 out-of-pocket.

Other options provided do not accurately define underinsurance. Overspending on a policy by insuring a property for more than its value does not represent a lack of coverage, but rather an excess. Policies with too many exclusions identify issues with coverage but don’t quantify underinsurance. A policy that cannot be renewed pertains more to its terms and conditions rather than the amount of coverage, and therefore does not relate to the concept of underinsurance.