A:

The 80% rule refers to the fact that most insurance companies will not fully cover the cost of damage to a house due to the occurrence of an insured event (e.g. fire or flood), unless the homeowner has purchased insurance coverage that is equal to at least 80% of the house's total replacement value. In the event that a homeowner has purchased an amount of coverage that 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.

For example, let's say that James owns a house with a replacement cost of $500,000 and his insurance coverage totals $395,000, but an unanticipated flood does $250,000 worth of damage to his house. At first glance, you might assume that since the amount of coverage is greater than the cost of the damage ($395,000 vs. $250,000), the insurance company should reimburse the entire amount to James. However, because of the 80% rule, this is not necessarily the case.

According to the 80% rule, 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. But since James did not buy the minimum amount of coverage, the insurance company would only pay for the proportion of the minimum coverage represented by the actual amount of insurance purchased - that is $395,000/$400,000, which amounts to 98.75% of the damages. Therefore, the insurance company would pay out $246,875 worth of the damages and, unfortunately, James would have to pay the remaining $3,125 himself.

Since capital improvements increase the replacement value of a house, it's 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 that James realizes that he did not purchase enough insurance to cover the 80% rule, so he goes and 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 the cost of any partial damages.

Inflation can also cause the replacement value of a house to creep up in value, so it would be wise for homeowners to periodically review their insurance policies and home replacement values to see if they have adequate coverage to fully cover partial damages.

To learn more, see A Tax Primer For Homeowners and Smart Real Estate Transactions.

RELATED FAQS
  1. What are some examples of unexpected exclusions in a home insurance policy?

    Learn about commonly excluded perils with different standard insurance policies. Explore events that homeowners should consider ... Read Answer >>
  2. What are some examples of when insurance bundling is a bad idea?

    Learn about situations where insurance bundling may not be a favorable option. Bundling insurance is often a good idea, but ... Read Answer >>
  3. What caused the European / Eurozone debt crisis?

    Understand how insurance companies price insurance premiums, and learn the importance of data and statistics in the insurance ... Read Answer >>
  4. Why is my insurance premium so high/low?

    Insurance premiums can be affected by many factors including: type and amount of risk size of deductible amount of coverage ... Read Answer >>
Related Articles
  1. Insurance

    The Beginner's Guide To Homeowners' Insurance

    Discover everything new homeowners need to know before they sign on the dotted line.
  2. Insurance

    What Is and Isn't Covered by Homeowners Insurance

    Understanding what your insurance covers can be confusing. Learn what almost all insurance policies have in common so you're prepared if disaster strikes.
  3. Insurance

    Do You Need Casualty Insurance?

    Find out how different types of coverages can protect you and which policy is right for you.
  4. Insurance

    5 Myths About Homeowner's Insurance

    Many homeowners believe their policies will cover them for any and all damages, but the reality can be an expensive surprise.
  5. Insurance

    6 Types Of Insurance Coverage You Didn't Think You Needed

    These different types of insurance coverage can be beneficial, but they're often overlooked and misunderstood.
  6. Insurance

    Insurance Coverage: A Business Necessity

    Don't go to work without this policy in place - especially if your work is in your home.
  7. Managing Wealth

    6 Insurance Policies That Protect the Wealthy

    Here are six types of insurance that the wealthy use to protect their assets.
  8. Managing Wealth

    The Best Way to Insure Your Jewelry

    What you need to know to keep those baubles, bangles and beads safe.
  9. Insurance

    For Top-Notch Insurance Coverage, Compare Quotes

    Find out how to use and compare policy options to get the best coverage at the best price.
RELATED TERMS
  1. Combined Physical Damage Coverage

    Combined physical damage coverage is an auto insurance policy ...
  2. Total Insurable Value

    Total insurable value is the value of property, inventory, equipment, ...
  3. Coordination Of Coverage

    A review or modification of an individual's or business’ insurance ...
  4. First Dollar Coverage

    An insurance policy feature that provides full coverage for the ...
  5. Fire Insurance

    Insurance that is used to cover damage to a property caused by ...
  6. Loss Settlement Amount

    A term used to denote the amount of a homeowner's insurance settlement. ...
Hot Definitions
  1. Agency Theory

    A supposition that explains the relationship between principals and agents in business. Agency theory is concerned with resolving ...
  2. Treasury Bill - T-Bill

    A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations ...
  3. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
  4. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure typically used by analysts to identify companies that generate ...
  5. Majority Shareholder

    A person or entity that owns more than 50% of a company's outstanding shares. The majority shareholder is often the founder ...
  6. Competitive Advantage

    An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers ...
Trading Center