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The Insurance Rule Nobody Knows About

Right now, we are seeing incredible growth in home prices across the country. As of March 2021, the median existing single-family home price was $334,500, up 18.4% from March 2020.1 If you live in a state like Utah, you’re likely seeing even greater growth in home prices. In addition, there has been a tremendous spike in the price of the materials needed to build a home. These two factors provide the perfect storm for being underinsured on your home insurance policy, which has something to do with a commonly used rule called the 80% rule.

80% Rule

The 80% rule is used by most insurance companies and it means 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 you purchase coverage for less than the minimum 80%, the insurance company will only reimburse you a proportionate amount of the required minimum coverage that should have been purchased.2

A little math, bear with me:

Kathy owns a home with a replacement cost of $500,000, and her insurance coverage totals $360,000. A flood causes $250,000 worth of damage to her house. You might think that this damage is fully covered because the amount of coverage is higher than the cost of the damage, but because of the 80% rule, that’s not true.

According to the 80% rule, the minimum coverage that Kathy should have purchased for her home is $400,000 ($500,000 x 80%). If she meets that coverage, all partial damage to Kathy’s home will be paid by the insurance company. However, Kathy did not buy the minimum amount of coverage, so the insurance company will only pay for the proportion of insurance owned relative to the 80% minimum ($360,000/$400,000), which comes to 90% of the damages.

Therefore, the insurance company would pay out $225,000 and Kathy would have to pay the remaining $25,000.2

How does this impact you?

Rising home prices, rising material costs, and home renovations increase the replacement value of your home. The total replacement cost value of a home is how much it would cost to completely replace it after a disaster. This includes the value of the square footage, roof, amenities, labor costs to rebuild, etc.3

If a few years ago your house was worth $500,000 you only needed $400,000 worth of coverage. Now, with rising home values your home is likely worth substantially more, say $600,000, and you should have $480,000 worth of coverage. In this case, if you have damage to your home, your insurance company will only cover 83.33% of damages (400,000/480,000) and you are obligated to cover the rest.

What should you do?

It may be time to speak with your insurance agent and update them on your home. Inform your provider about any renovations or additions you have made. It’s likely your premium will also increase, but it’s a small price to pay for your needed coverage.

A lot of policies also add an inflation guard coverage endorsement to your policy, so you can remain fully covered without having to remember to update your dwelling coverage each year.4

 

Sources
  1. https://www.nar.realtor/newsroom/housing-market-reaches-record-high-home-price-and-gains-in-march#:~:text=The%20median%20existing%20single%2Dfamily,29.1%25%20from%20one%20year%20ago.
  2. https://www.investopedia.com/ask/answers/06/80percentrule.asp
  3. https://www.quantummga.com/blog/making-sure-clients-understand-the-80-rule-in-home-insurance.aspx
  4. https://www.youngalfred.com/homeowners-insurance/what-is-the-80-percent-rule-in-homeowners-insurance
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