The 80% Factor: Why Homeowners Insurers Require It

Consumers are often frustrated by the amount of insurance their mortgage company requires them to carry on their home.

Sometimes that amount is greater than the home’s market value; often it’s more than the amount remaining on the mortgage.

But many insurers still insist your home be insured for at least 80% of its replacement cost. Not its market value.

Here is the reasoning behind this and how it can help you.

First, the homeowners’ policy will replace – not just repair – damaged property. That means hardwood floors will be replaced with hardwood, not laminate, as it might be without this replacement clause.

Second, 96% percent of all homeowners’ losses are partial; only 4% of homes suffer a total loss.

Next, think of insurance as a big pool of money.

All insurance buyers put their premiums into this pool, and the insurance company invests the money and uses it to pay claims and expenses.

Insurers know if they collect premiums on limits of insurance equal to 80% of replacement cost, they will have enough money in the pool to pay full replacement cost for partial losses.

So if you don’t carry an amount of insurance that equals 80% of your home’s replacement cost, you will be penalized in the event of a partial loss.

Here is the formula used to calculate a partial payment:
(Amount of Insurance Carried / Amount of Insurance Required) x Amount of Loss

For example; your home has a replacement cost of $500,000. However, you must carry at least $400,000 in coverage (80% of replacement cost).

You owe only $300,000 on the mortgage, so that’s all you decide to carry. However, this is only 75% of the $400,000 you require.

If a fire causes $50,000 in damage you will receive only a 75% ($37,500) payment for this partial loss because you are carrying only 75% of the required amount.

Be advised there are some insurance companies that require 100% insurance to replacement cost value.