Charles and Darlene Nelson didn't think a lot about their homeowners' insurance policy after they moved into the modest home they built in 1990 to enjoy their retirement.

But in 2009, Charles took a closer look at his policy statement and realized they were paying too much.

American Family Mutual Insurance Co., the state's second-largest homeowners insurer, had increased the cost to replace their Wright County home from $184,000 in 2004 to more than $400,000. By 2011, it was $454,500, with another $363,000 for the contents.

"What got my dander up was the doggone contents," Charles Nelson said. "I don't know anybody that has $360,000 of personal property in their house."

Given American Family's size, the Nelsons suspect there are other Minnesota customers who have run into the same issue they allege.

Their case offers a window on a critical but somewhat mysterious part of the property insurance industry: the methodology companies use to establish the replacement costs for dwellings and contents for new policies and renewals. Particularly worrisome, according to consumer advocates, is the widespread use of third-party vendors to help establish the replacement value of homes.

"I think there's a temptation on the part of the vendors to beat out competitors by being able to tell insurance companies you'll make more money if you use my product," said J. Robert Hunter, director of insurance for the Consumer Federation of America and a former Texas insurance commissioner.

The Nelsons filed a lawsuit Thursday, arguing that American Family's methodology for determining policy values is flawed. They're seeking class-action status.

The company declined a request for an interview. In a written statement, a spokesman said American Family will respond to the lawsuit in court. It regularly adjusts replacement costs for inflation, spokesman Steve Witmer said in the statement, and policyholders expect their coverage to replace their home if it is destroyed.

"A house fire or other catastrophic loss is the wrong time to find out that your insurance limits have not kept pace with the routine increases in the cost of labor and materials," he said.

The lawsuit, filed in Hennepin County District Court, accuses the insurer of deceptive trade practices and unjust enrichment. It seeks an injunction to stop the practice and also seeks damages, estimated at less than $4 million, for affected policyholders in Minnesota over the age of 62.

"AmFam's estimates of replacement value exceed anything one would come up with using appraisal standards accepted by professionals nationwide," said one of the Nelsons' attorneys, Bert Black of the Schaefer Law Firm in Minneapolis.

Insurance is regulated at the state level. A spokeswoman for the Minnesota Department of Commerce said that except for this instance, agency staff can't recall any other homeowners with similar complaints, but that the search criteria for public complaints filed with the agency were not set up in a way to know that for sure.

Minnesota, the spokeswoman said in a statement, "does not have express statutory or regulatory provisions that detail establishment of replacement costs of dwellings for purposes of homeowners insurance."

American Family, based in Madison, Wis., has more than 210,000 policies in Minnesota, second only to State Farm.

At issue is the Nelsons' rambler with a walkout basement on Eagle Lake in Wright County. Charles, a former utility worker, and Darlene, who worked in a metal stamping plant, say that in 2004 their American Family policy put the replacement value at $184,000, with contents at $147,200. By 2011 it had ballooned to $454,500 with contents at about $363,000.

That's far out of proportion to their lifestyle, Charles said. They clip coupons, he said, and beyond a baby grand piano they bought from a relative and some antiques, they don't have much.

According to the lawsuit, American Family automatically values a home's contents at 80 percent of the replacement cost of the dwelling.

In an interview, Charles said he trusted his agent, who worked for American Family but recently retired. Nelson described him as very responsive.

When the Nelsons complained about the replacement value, the agent drove out to their house and agreed it was too high, Nelson said, but he didn't offer a full explanation of how it got there.

The agent worked to get the supersized replacement cut down to $315,000. Despite that, American Family refused to issue a refund for years of overcharges. Nelson and his attorneys figure it amounts to about $3,500.

The former agent declined to comment for this article.

The money isn't the point, Nelson said. "Nobody likes to have their pocket picked. Nobody does," he said. "There was abuse going on here."

Between 2004 and 2011, the national average cost to rebuild a home rose 25 percent, according to Marshall & Swift, a leading supplier of construction cost data.

American Family began outsourcing home inspections -- a common industry practice -- to a national inspections company called Millennium Information Services Inc. in Itasca, Ill., in 2010.

In an interview, Millennium's president and CEO, Steve Pietrzak, said he understood that before then, American Family used a clearinghouse for routine inspection vendors.

Pietrzak said this is the first he's heard of the Nelsons' dispute, and didn't know whether the inspections Millennium was providing for American Family included home interiors. Their clients instruct them on what methodology to use, he said. "It's obviously not an exact science," Pietrzak said.

Jennifer Bjorhus • 612-673-4683