The 80% rule is the term used by insurers to refer to the arrangement that they don’t cover the whole cost of the loss of a house in case an event covered by the insurance occurs (resource link). These events include fire and flood. Full coverage occurs only if the house owner had paid for home insurance that’s equal to 80% of the total value of the house.
For example, let’s assume that a specific owner has a house that has a total replacement value of $500,000 but with a $395,000 coverage. A flood occurs and causes a loss of $250,000 due to the damages. From these figures, a person would assume that the insurance will pay for the total damages of $250,000 since the client’s cover is more than the damages caused. However, this won’t be the case since the 80% rule will be applied.
Based on the 80% rule, the client should have purchased a total of $400,000 calculated as ($500,000 x 80%). If this provision was met by the client, the insurance company could have covered the total loss that occurred during the flood.
Since the client didn’t meet the minimum threshold, the company will compensate for only a part of the total insurance purchased which is calculated as $395,000/$400,000. This amounts to a total of 98.75% of the loss, hence they would only pay a total of $246,875 and the client will have to cover for the remaining $3,125.
Impacts of Capital Improvements on the 80% Rule
A capital improvement is accompanied by an increased replacement value for the house. The amount that was previously enough to meet the 80% rule before the improvement won’t be enough after the capital improvements.
Let’s assume that the client in the example above realized that he did pay enough money to meet the 80% rule. He decides to pay for coverage that covers for a total amount of $400,000. After one year, he decides to add some improvements, thus raising the replacement value to $510,000.
Though the initial amount of $400,000 was sufficient to cover for the $500,000 value, the capital improvement has increased the replacement value of the house where the initial amount of $400,000 will now be at 78.43%. If damages occur, the coverage won’t be in a position to allow for the payment for the partial damages.
Impacts of Inflation
Inflation significantly affects the economy and insurance coverage is not spared. It leads to the increased replacement value of houses where the initial paid amount might not be enough to cover for the total damages of a house even in an event where the paid amount had previously meet the 80% rule.
It’s advisable for homeowners to regularly review their coverage to see if they still have enough coverage to fully pay for partial damages.
All homeowners should understand how the 80% rule of insurance coverage works. There are several factors that might affect replacement value such as a change in capital and inflation. As a client, you should understand all these factors and adjust the coverage accordingly. Consulting your insurance provider will be a good idea to get more advice.