The 80% Rule

What Is the 80% Rule for Home Insurance?

The 80% rule is adhered to by most insurance companies. 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 purchased covers less than 80% of the replacement value, the amount paid by the insurance company will be proportionate 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

For example, Bruce & Diane 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 Bruce and Diane's house. At first glance, you might assume since the amount of coverage is higher than the cost of the damage ($395,000 vs. $250,000), so the insurance company should reimburse the entire amount to Bruce and Diane. However, because of the 80% rule, this is not necessarily the case.

According to the 80% rule, the minimum coverage that Bruce and Diane 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 Bruce and Diane's home would be paid by the insurance company. However, since Bruce and Diane 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. Therefore, the insurance company would pay out $246,875?and,?unfortunately, Bruce and Diane would have to pay the remaining $3,125 himself.

?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. This is especially important today when in a environment of rapid inflation and skyrocketing cost to rebuild home values.

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 after.

For example, let's say Bruce and Diane realize they did not purchase enough insurance to cover the 80% rule, so they purchase coverage that covers $400,000. One year passes, and Bruce and Diane decide 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 partial damages.

Inflation?can also cause the replacement value of a house to increase. Therefore, homeowners should review their insurance policies and home replacement values periodically to see if they have adequate coverage to cover any damages fully.

In 2022 over 32% of the Homes reviewed were under the 80% rule according to one leading national insurer. Cambridge Risk Advisors would be happy to engage in a full review of your personal insurance policies.

Best Regards,

Shaun Gagnon