How is home insurance calculated?

Q: What is the 80% rule in homeowners insurance?

The 80% rule in home insurance, also called the 80/20 rule , requires you to have your home insured for at least 80% of its replacement cost in order to have claims paid in full. Partial claims may be reduced based on the difference between your coverage and the replacement cost; total loss claims are not affected.

How is home insurance calculated?

Home insurance is calculated using a basic calculation of what's known as pure premiums, which are then adjusted based on the company's operating costs, or expense ratio, for a gross premium. That premium is then adjusted based on the details of the home (construction type, square footage, materials, features and age) and details about you and your household (credit and claims history, pets, smoking and more.)

Here's a breakdown of how those steps work to calculate your final premium.

1. Calculating the pure premium

If an insurer wants to set its premium for a group of homeowners, it first divides the losses associated with that group by its exposure. If, during the previous year, the losses for properties valued at $100 million totaled $5,000,000, that result would be 5% or five cents per dollar of property value, just to cover losses (what is paid out in claims) This figure is called a "pure premium."

2. Calculating the expense ratio

Next, the insurer determines its administrative and other costs, like commissions paid to agents, maintaining office buildings, paying support staff and even taxes. It then builds in its desired profit to set how much the company needs to make after paying all of the costs associated with doing business. That is usually expressed as a percentage called the "expense ratio." 26.5% is the industry average, according to S&P Global.

3. Setting the base premium

Insurance companies use a calculation of the pure premium and the expense ratio to get the gross premium. That's sort of a base rate for home insurance in your area.

4. Adjusting for the home and homeowner

Starting with the base premium, the insurance company will adjust the rate based on a wide variety of factors. First, the home itself is considered, with a detailed calculation of its replacement cost based on age, construction type and materials used inside and out, the square footage of the home and any decks or porches and details of features like fireplaces. Then, the homeowner and household are considered, looking at past claims, credit, pets in the home and even whether anyone in the home smokes. Increases in rates due to risks are referred to as surcharges.

5. Finalizing the premium with discounts

With the adjusted premium in hand, the insurance company will finalize the rate by subtracting any discounts for which you qualify. Some of these will be based on details learned during the previous step, like discounts for hail-resistant roofing. Others, like bundling discounts, are applied in the final step.

What information is needed for a home insurance quote?

To get an accurate home insurance quote, you'll need to know the age, construction type and materials, bedroom and bathroom count of the home and provide details about who will be living in the home. Use this homeowners insurance checklist when gathering information for your quote:

The address of the home
The year it was built
Construction type
Roof and siding materials
Square footage
Number of bedrooms and bathrooms
Interior materials such as flooring type and counters
Who lives in the home
Any pets in the home, particularly dogs
Any special features about the home, like fireplaces, stained glass windows, jetted tubs or vaulted ceilings

What is the formula for calculating homeowners insurance?

Based on the steps above, a simplified version of the formula for calculating home insurance premiums would look like this:

Base rate for your home based on replacement cost and selected coverages + surcharges - discounts = your final premium.

To create a home insurance estimate yourself, you can get a loose number using your home's replacement cost and a home insurance calculator. Multiplying the home's square footage by the cost to rebuild is a quick way to determine replacement cost, which is the dwelling coverage for your home. For example, let's assume your home is 2,000 square feet and the average cost to build per square foot is $150 (this cost will vary depending on your location, home type, etc.) So, 2,000 X $150 = $300,000 dwelling coverage.

Since we recommend insuring 100% of your rebuild cost, plug that dwelling coverage number into our home insurance calculator along with your ZIP code, liability coverage amount and chosen deductible.

How are homeowners insurance rates determined?

Homeowners rates are determined using underwriting software that takes all of the information on a home and the area in which it's located and calculates a rate based on replacement cost and risk. Insurance agents don't handle any rate calculations, according to David Meltzer of East Insurance Group in Baltimore, Maryland.

"We're able to advocate for the insured when there's a claim, but the days of agents setting rates for clients have long passed," he said.

He added that insurers don't reveal their underwriting processes because they're competing with other carriers.

"They keep their algorithms top secret," he said.

Here are common factors that determine rates:

Replacement cost of the home (higher cost = higher rates)
Age of the home (newer homes can be cheaper to insure)
Home square footage (larger homes are more expensive to rebuild and have higher premiums)
Number of primary inhabitants (larger households increase potential liability)
Construction type (fire-safe materials like masonry are cheaper to insure than wood)
Roof type (fire-retardant asphalt or metal is preferable to wood shakes)
PPC (Public Protection Classification, which measures the proximity of fire station, police, hydrants, etc. A "1" is the best; a "10" is the worst.)
Area claim history (if neighbors file lots of claims, it can increase your rates)
Personal claim history (if you file more than average claims, your rates will be higher)
Pets (a dog with a bite history or breeds considered more dangerous can increase rates)
Owner's credit score (statistics show that people with lower scores file more insurance claims)
C.L.U.E. report of the property, which lists claims filed by the previous owners in addition to you. If the cause of the claims has not been resolved, your rates will be higher.
Security or alarm system (alarms and monitoring help decrease rates)
Fire alarm system
Deadbolt locks
Neighborhood crime rate (higher crime areas cause higher insurance rates)
Attractive nuisances (swimming pools, ponds, machinery, playground equipment, trampolines) increase liability potential and insurance premiums
Coverage levels, including endorsements

If one or more of the factors listed here is costing you money and can't be changed (like your location), check with other insurers. A different company might not rate your Rottweiler or neighborhood the same way, and you could pay less for your coverage.

How much is homeowners insurance?

Homeowners insurance costs an average of $2,543 a year, or $212 a month, nationwide for a policy with dwelling coverage and liability limits at $300,000 and a $1,000 deductible. Home insurance rates vary by location and carrier.

The same policy at $200,000 in dwelling coverage averages $160 per month, while it averages $367 a month at $600,000 in dwelling coverage.

How much should homeowners insurance increase each year?

There's no set amount for annual increases, as it depends on a lot of factors. Home insurance follows inflation but may not go up exactly in line with overall inflation. That's because the cost of construction materials may rise at a higher rate. Insurance companies will also adjust for claims paid, both claims you have filed and claims filed in your neighborhood that indicate a higher risk.

In addition, any changes you have made to the home will affect your rates. That includes renovations and additions, or even things that increase the risk, like adding a swimming pool.

How to lower homeowners insurance

To save money on home insurance, raise your deductible, bundle your coverage with auto insurance and ask about discounts. Reduce the risk of a claim with security features and updates like a new roof.

Raise your deductible. You'll pay lower premiums with a higher deductible, so choose the highest one you can afford.
Bundle your coverage with one insurance company. You'll get a discount on both home and auto insurance.
Ask about discounts. Find out which home insurance discounts are available and how to qualify for them.
Add security features. Consider making your home safer with a monitored security system, motion-sensing lights, and upgraded locks, windows and doors.
Complete home improvements. Updating your roof or adding weather protection like storm shutters can reduce your rates.

FAQ: Calculating home insurance

What is a home insurance premium?

Your premium is what you pay for coverage, also called your homeowners insurance rate. Home insurance premiums are calculated on an annual basis and reviewed each year. Premiums change annually following the cost of construction and other factors.

How much should you spend on homeowners insurance?

The average home insurance rate for $300,000 dwelling coverage and $300,000 liability with a $1,000 deductible is $2,543 annually, but how much you should spend depends on where you live, the specifics of your home and the coverage you choose. Find the best rate that provides the coverage you need; don't cut coverage to save money.

What is the 80% rule in homeowners insurance?

The 80% rule in home insurance, also called the 80/20 rule, requires you to have your home insured for at least 80% of its replacement cost in order to have claims paid in full. Partial claims may be reduced based on the difference between your coverage and the replacement cost; total loss claims are not affected.

Why did my homeowners insurance go up?

Your home insurance rate may have gone up due to inflation, changes to the risk in your area or on your property, claims and changes made to your property, like additions or improvements. If you're unclear on why your rate went up, call your insurer.