How Does the 80% Rule for Home Insurance Work?

What Is the Home Insurance 80 Percent Rule?

Most insurance firms adhere to the 80 percent guideline. An insurer will only cover the cost of damage to a home or property if the homeowner has obtained insurance coverage equal to at least 80% of the house's entire replacement value, according to the standard. The insurance provider will only refund the homeowner a proportionate amount of the statutory minimum coverage that should have been acquired if the quantity of coverage purchased is less than the minimum 80 percent.

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KEY TAKEAWAYS: 

• An insurer will only completely cover the cost of damage to a home if the owner has bought insurance coverage equal to at least 80% of the home's entire replacement value.
• The amount paid by the insurance carrier will be proportionate to the amount of coverage initially obtained if the policy purchased does not cover more than 80% of the replacement value.
• The 80 percent rule and the value of a property are affected by capital upgrades and inflation.

How Does the 80 Percent Rule Affect Home Insurance?

James, for example, owns a house worth $500,000 and has $395,000 in insurance coverage. James' house suffers $250,000 in damage due to an unplanned flood. At first look, you may think that because the coverage amount is greater than the cost of the damage ($395,000 vs. $250,000), the insurance company should reimburse James in full. This is not always the case, however, due to the 80 percent rule.

According to the 80 percent rule, James should have purchased $400,000 in coverage for his property ($500,000 x 80 percent). If that threshold was attained, the insurance company would cover any and all partial damages to James's home. However, because James did not obtain the bare minimum of coverage, the insurance company will only pay for the proportion of the bare minimum indicated by the actual amount of insurance purchased ($395,000/$400,000), or 98.75 percent of the damages. As a result, the insurance company would pay out $246,875 and James would be responsible for the remaining $3,125.

How Does the 80 Percent Rule Affect Capital Improvements?

Because capital upgrades enhance the replacement value of a home, coverage that would have sufficed to fulfill the 80 percent criterion prior to the modifications may not suffice afterward.

For example, suppose James learns he didn't get enough insurance to cover the 80 percent requirement, so he buys $400,000. After a year, James decides to construct a new addition to his home, bringing the replacement value up to $510,000. While $400,000 would have been enough to cover the $500,000 house ($400,000/$500,000 = 80%), the capital improvements have increased the house's replacement value, and this coverage is no longer adequate ($400,000/$510,000 = 78.43 percent). The insurance provider will not fully pay the cost of any partial damages in this scenario.

The replacement value of a home might also rise as a result of inflation. As a result, homeowners should examine their insurance plans and home replacement values on a regular basis to ensure that they have enough coverage to cover any damages completely.