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80/20 Rule Home Insurance

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80/20 Rule Home Insurance

You might have heard of the 80/20 rule in regards to health insurance, but what does it mean for homeowners insurance? When it comes to homeowners insurance, you as the homeowner must have dwelling coverage for at least 80% of your house’s replacement cost in order for your insurance provider to cover the costs of a claim. To meet the rule, you must understand your homeowners insurance policy and ensure you are not underinsuring your home. 

If a natural disaster, accident or fire damages or destroys your house, your insurance provider will determine the amount they’ll pay for your claim by checking whether your premium covers the 80% of the replacement value minimum or not. If your premium is less than that minimum you are underinsured and at risk for paying a very large amount for a coinsurance penalty. 

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How the 80/20 Rule Works in Homeowners Insurance

Like the 80/20 rule in regards to health insurance, the payment structure is fairly similar. First, you pay the deductible and if you meet the 80% dwelling coverage minimum, then your insurance provider pays for the damages. It’s when you don’t meet the dwelling coverage minimum that costs can rise very quickly for you, as the homeowner.  

For example, say you purchase a house that is a bit of a fixer-upper at a discount for $270,000 market price. In order to rebuild the home, it would cost $380,000 in replacement value. Unfortunately, a fire causes $101,000 in damages but you have homeowners insurance and a $1,000 deductible. 

If your home’s insurance policy only has $270,000 in dwelling coverage, which is only 71% of the home’s replacement cost, you are underinsured. So how much would you have to pay? Well, first you pay the $1,000 deductible and then you would pay the coinsurance penalty. To calculate the coinsurance penalty you would need to know how much the minimum 80% dwelling insurance cost would be. 80% of the $380,000 replacement value is $304,000 and how much your policy should cover in dwelling insurance. Now you divide your actual dwelling coverage, $280,000 by your minimum dwelling coverage, $304,000 and multiply that decimal by the remaining costs of damages after the deductible, in this case $1,000. That gives you the amount your insurance provider would pay, which in this example is $92,105.26 and the coinsurance penalty, which is the difference of the cost of damages and how much the insurance provider pays, is $8,894.74. In total, with the $1,000 deductible, you would pay $9,894.74 total in this example.

Why There are Underinsured Homes

Did you know that roughly 60% of homes across the United States are underinsured by at least 15%? This statistic shows that many homeowners across the country are at risk for paying a lot of money in the event their homes are damaged or destroyed due to their homeowners insurance not fully covering for repairs. 

The most common reason homes are underinsured is because people believe in false savings. Many homeowners insurance companies offer low rate policies that appear to be cheaper for the homeowner every month. While you can save money upfront by paying low premiums every month, this also generally means that your home isn’t covered properly. The old adage about getting what you pay for is true, and in this case, saving a few dollars every month means that your home is underinsured and you could pay thousands in the event of damage or destruction to your home.

Annual inflation and home improvement projects can also lead to your home being underinsured. 

How to Avoid the Negative Effects of the 80/20 Rule

The best way to avoid being underinsured and suffer from the negative effects of the 80/20 rule in homeowners insurance is to review your policy. Understand your home’s current dwelling coverage and replacement value to ensure you meet the 80% dwelling coverage minimum and are not underinsured. Remember to speak with an agent from your insurance provider to keep them updated on your home and any additions or renovations. While it may cost more every month to meet your home’s minimum dwelling coverage, at least you won’t be surprised by a large bill that your homeowners insurance company will not pay in the event of damages or destruction.

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