What Is the 80% Rule for Home Insurance?

The 80% rule is adhered to by the majority of insurance providers. The standard stipulates that an insurer will only cover the cost of damage to a home or property if the homeowner has purchased insurance coverage equal to at least 80 percent of the home's total replacement value. If the coverage purchased falls below the required minimum of 80%, the insurance company will only reimburse the homeowner a proportional amount of the minimum coverage that should have been purchased.

How the 80 Percent Rule Affects Home Insurance

For instance, Diana owns a residence with a replacement cost of $500,000, and her total insurance coverage is $395,000. Unexpected flooding causes $250,000 in damages to Diana's home. Since the amount of coverage is greater than the cost of the damage ($395,000 versus $250,000), it may appear that the insurance company should reimburse Diana for the entire amount. Nonetheless, due to the 80% rule, this is not always the case.

According to the 80% rule, Diana should have purchased a minimum of $400,000 in coverage for her home ($500,000 x 80%). If this threshold had been met, the insurance company would have paid for any and all partial damages to Diana's home. However, because Diana did not purchase the minimum amount of coverage, the insurance company will only pay 98.75% of the damages ($395,000/$400,000) or the proportion of the minimum coverage represented by the actual amount of insurance purchased. Therefore, the insurance company would pay out $246,875, and Diana would be responsible for the remaining $3,125.

How Capital Expenditures Impact the 80% Rule

Since capital improvements increase a home's replacement value, it is possible that coverage that would have been sufficient to meet the 80% rule before the improvements, will no longer be adequate afterward.

For instance, let's say Diana realizes she did not purchase enough insurance to comply with the 80% rule, so she purchases $400,000 in coverage. After one year, Diana decides to build a new addition to her home, thereby increasing the replacement value to $510,000. While the $400,000 would have been adequate to cover the $500,000 home ($400,000/$500,000 = 80%), the capital improvements have increased the home's replacement value, making this coverage inadequate ($400,000/$510,000 = 78.43%). In this instance, the insurance company will not fully compensate the cost of any partial damages.

Inflation can also cause a home's replacement value to rise. Therefore, homeowners should periodically review their insurance policies and home replacement values to determine whether their coverage is sufficient to cover all damages.