Following the example above, let’s say you secured insurance for $220,000—or 80% of the replacement cost of your home—when you first purchased it. Then, you renovated your home, and these improvements significantly raised the replacement cost of your home to $350,000. For your insurance company to fully cover claims, you’d need to increase your insurance coverage to reflect 80% of the new replacement cost of your home, which would be $280,000 in this case. A storm causes $100,000 of damage to your home, but because you increased the amount of insurance on your home to $280,000, the insurance company covers the total cost of the repairs, minus your deductible.
Let’s say you didn’t adjust your insurance coverage, so you only had $220,000 in coverage for your home that is now worth $350,000 to replace. Instead of having at least 80% of the new replacement cost of your home insured, which would be $280,000, you only have 62.86% of the total cost insured. In the event of a claim, the insurance company would divide the amount of coverage you purchased ($220,000) by 80% of the replacement cost of your home ($280,000) and only cover the difference between those two amounts. So, in the same scenario from above, instead of the insurance company paying the full $100,000 (minus your deductible) to repair the damage caused by the storm, they would only pay roughly $78,570, as the difference between the amount of insurance you purchased and the 80% replacement cost was 78.57%. You would then be responsible for paying the remaining $21,430 in repair costs, plus your deductible.
As you can see, failing to adjust the amount of insurance you have on your home to ensure you’re following the 80% rule can be extremely costly. Regularly reviewing your coverage amounts, especially after you’ve done home renovations, can help you make sure you’re properly covered, even if your home’s replacement cost increases.