What Is the 80/20 Rule in Home Insurance?

The 80/20 rule is an insurance industry standard that stipulates you should insure your home for at least 80% of its replacement cost.^[1] An insurance company might cover less than the full claim amount you make against your policy if you don’t adhere to this rule.

For example, if your home is worth $400,000 at current prices, you need to buy at least $320,000 of coverage if you want the insurer to fully cover your claim.

If you make renovations that increase your home’s value, it’s important to adjust the amount of insurance coverage you have. Here’s what you need to know about the 80/20 rule and how it works with your homeowners insurance policy.

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How the 80% rule for home insurance works

When you purchase a house, your home insurance policy protects against the risk of loss due to a natural disaster, vandalism, and other hazards or certain activities. Home insurance can also cover medical care for people who get injured on your property.

If you don’t buy home insurance for at least 80% of the home’s replacement value, your insurer might not fully cover repairs or costs when you file a claim.

Here’s an example that illustrates how costly not following the 80% rule can be. Let’s say your home’s replacement cost value is $475,000 and your current insurance coverage is $350,000. A tornado hits your home and causes $150,000 in damages.

Even though the damages are much less than your home’s dwelling coverage amount, you would need to have $380,000 in dwelling coverage to meet the 80% threshold, so your insurer would only cover a portion of your storm damage claim.

Insurance companies prorate the amount they’ll pay by the actual amount of coverage you have ($350,000/$380,000), which comes out to 92% of the damages.

This is how the numbers break down:

• Home’s replacement cost value: $475,000

• Current insurance coverage: $350,000

• Required coverage to meet the 80/20 rule: $380,000 ($475,000 × 0.8)

• Cost of damages: $150,000

• Percentage of the claim your insurer will cover (based on your $350,000 coverage): 92%

• Insurance claim payout amount: $138,000 (0.92 × $150,000 in damages)

• Your out-of-pocket cost: $12,000 ($150,000 - $138,000)

Risks of not following the 80% rule

If you fail to insure your home for at least 80% of its replacement cost, the insurance company might not cover the total cost of the repairs. You might not be able to afford repairs or the total replacement cost of your home without the help of a homeowners insurance company.

Whether you’re buying your first home or you’re on your third home, you need to weigh the risks of insuring less than 80% of your home’s value against the costs of paying a larger share out of pocket for covered damages.

You might pay lower premiums if you don’t get enough coverage to meet the 80% rule, but you could end up paying much more later — especially if your home’s overall replacement cost increases. Keep in mind that your deductible is another out-of-pocket cost. 

How to calculate a payout if you don’t follow the 80% rule

To calculate how much to pay out in a claim for a homeowner that doesn’t follow the 80% clause, the insurance company will use a formula to multiply the cost of the damage by the amount of coverage you have ($150,000 × $350,000) and divide it by the amount of coverage your homeowner’s insurance policy should have ($380,000).

In this example, the total comes to $138,000. Then the company will subtract the deductible. If you have a deductible of $1,500, the company will pay $136,500.

If you don’t follow the 80/20 rule, in this case, you’re paying $13,500 out of pocket rather than just the $1,500 deductible. When buying a homeowners insurance policy, you should keep this in mind since it could cost you even more later.

Your premiums could be slightly higher when you add more insurance coverage. But paying more for insurance today might be less expensive in the future if you don’t have enough insurance to pay for repairs.

Replacement cost value vs. market value

The market value of your home is the amount you could sell it for in today’s real estate market. The replacement cost value of your home is how much it would cost to rebuild, based on local per-square-foot building costs.

Both these numbers can fluctuate over time. But when insuring your home, make sure you’re purchasing dwelling coverage of at least 80% of its replacement cost value.^[2]

Factors that affect a home’s replacement cost value

When calculating your home’s replacement cost and how much insurance you should buy, these are some factors you should consider:

• Whether home prices have increased in your area in response to the real estate market

• If you’ve made capital improvements to the house, including updating an older home or changing a modern home’s structure

• Potential inflation in the cost of similar materials to rebuild your home, though some insurance companies offer inflation guards in policies to combat rising consumer prices^[3]

How home improvements affect the 80% rule

Making home improvements or renovations can also affect the overall cost to replace your home. Updating your home could mean your coverage no longer meets the 80% rule.

If you plan to make upgrades, talk to your insurer about the potential impact. You might need to increase your home insurance coverage to properly insure your home’s value. Make sure you have enough coverage and include the value of your renovations and improvements in your calculations.

Home insurance and 80% rule FAQs