What Is the 80% Rule for Home Insurance?
Most insurance companies adhere to the 80% rule. According to the standard, an insurer will only cover the cost of damage to a house or property if the homeowner has purchased insurance coverage equal to at least 80% of the house's total replacement value. If the amount of coverage purchased is less than the minimum 80%, the insurance company will only reimburse the homeowner a proportionate amount of the required minimum coverage that should have been purchased.
Key Takeaways
- The 80% rule means that an insurer will only fully cover the cost of damage to a house if the owner has purchased insurance coverage equal to at least 80% of the house's total replacement value.
- If the coverage is for less than 80% of the replacement value, the insurance company will pay a proportionate amount to the amount of coverage originally purchased.
- Capital improvements and inflation affect the value of a property and the 80% rule.
How the 80% Rule Works for Home Insurance
Purchasing homeowners insurance can protect you from financial losses if your home is damaged by unforeseen disasters, burglaries, and fires. If you have a mortgage loan, your mortgage lender will likely require you to buy homeowners insurance. However, you must purchase enough insurance to cover the cost of repairs or replacing the items damaged.
Insurance companies may require you to purchase enough insurance to cover a minimum of 80% of the replacement cost of your home. You agree to pay the insurer the monthly premiums for the coverage. If damage occurs to the home, the insurer pays the replacement cost value of the claim for repairing the damage.
However, replacement costs can increase over time due to inflation, which is the pace of rising prices in an economy. If inflation occurs and the homeowner doesn't increase their insurance coverage, they might have insufficient coverage for 80% of the home's replacement value. As a result, the homeowner would need to pay for the repairs for the uninsured portion.
Example of the 80% Rule for Home Insurance
James owns a house with a replacement cost of $500,000, and his insurance coverage totals $395,000. An unanticipated flood causes $250,000 worth of damage to James' house. At first glance, the amount of coverage appears to be higher than the cost of the damage ($395,000 vs. $250,000), so the insurance company should reimburse James the entire amount. However, because of the 80% rule, this is not necessarily the case.
The minimum coverage that James should have purchased for his home is $400,000 ($500,000 x 80%). If that threshold had been met, any and all partial damages to James's home would be paid by the insurance company.
However, since James did not buy the minimum amount of coverage, the insurance company will only pay for the proportion of the minimum coverage represented by the actual amount of insurance purchased ($395,000/$400,000),which amounts to 98.75% of the damages.
Here are the numbers:
- Home replacement cost value: $500,000
- Existing insurance coverage: $395,000
- Coverage required under the 80% rule: $400,000 (0.80 * $500,000)
- Actual percentage covered of the $400,000: 98.75% ($395,000 / $400,000)
- Cost of damages: $250,000
- Insurance claim payout: $246,875 (98.75% * $250,000 in damages)
- Customer's out-of-pocket cost: $3,125 ($250,000 - $246,875)
Since James only bought 98.75% of the required $400,000 in insurance coverage, the insurance company only covered 98.75% of the replacement cost. James must pay the remaining $3,125 out of pocket.
Because improvements to a home and inflation affect home values, homeowners should review their insurance policies periodically to ensure their coverage meets the 80% rule.
How Capital Improvements Affect the 80% Rule
Since capital improvements increase the replacement value of a house, it is possible that coverage that would have been enough to meet the 80% rule before the improvements will no longer be sufficient.
For example, let's say James realizes he did not purchase enough insurance to cover the 80% rule, so he purchases coverage that covers $400,000. One year passes, and James decides to build a new addition to his house, which raises the replacement value to $510,000.
While the $400,000 would have been sufficient to cover the $500,000 house ($400,000/$500,000 = 80%), the capital improvement has driven up the replacement value of the house, and this coverage is no longer enough ($400,000/$510,000 = 78.43%). In this case, the insurance company will once again not fully compensate for the cost of any damages.
Inflation can also cause the replacement value of a house to increase. Therefore, homeowners should periodically review their insurance policies and home replacement values to see if they have adequate coverage to cover any damages fully.
What Is Not Protected by Most Home Insurance Policies?
Typically, homeowners insurance does not cover flood, earthquake, or damage caused by poor upkeep and normal wear and tear.
What Does 80% Coinsurance Mean in a Homeowners Policy?
If a homeowner fails to insure their home for a minimum of 80% of its value and a claim is filed, the coinsurance clause will kick in. The insurance company will cover the percentage of the replacement cost comparable to the homeowner's deficient coverage of the 80% minimum. The repair costs that exceed the coverage would be the homeowner's responsibility to pay out-of-pocket.
How Do Insurance Companies Determine Dwelling Value?
The insurer will determine the replacement value through multiple factors, including the home's location, size, age, and condition.
The Bottom Line
The 80% rule means that an insurance company will pay the replacement cost of damage to a home as long as the owner has purchased coverage equal to at least 80% of the home's total replacement value. If the homeowner fails to purchase adequate coverage, the insurance company will pay an amount proportionate to the coverage originally purchased.
