Why does the plumbing inspector think it needs to be replaced? And is this inspector a local government employee or some other kind of inspector?

Sorry forgot to state: Independent plumbing inspector, heater was 12 years old, it came with a 6 year warranty. He said it was very inefficient, way too big for two people. Since electricity is very expensive in Hawaii, I should consider getting a newer, smaller unit which will be cheaper to operate

Here's my take:

1. It may be getting to the end of its useful life, but it sounds like there is nothing wrong or malfunctioning at the moment. My water heater is 17 years old and is still functioning just fine, although I realize it's living on borrowed time. So when it fails, I'm ready to replace it.

2. Your 12 year old water heater will already have a good level of insulation, and, since a new one would be running on electricity also, a new tank is unlikely to be much more efficient. Recent efficiency gains in water heater technology mainly have to do with tanks that have combustion systems, like natural gas. So I doubt that you will see big energy savings from switching to a "more efficient" unit...perhaps a couple of percent, if that. If you switch to a smaller tank, there will be some savings because a smaller tank has less surface area to transfer heat, but the savings will not knock your socks off in your climate.

3. What mainly drives costs is that the groundwater coming in to the water tank must be heated from its inlet temperature to about 120 degrees F. In places that get cold in the winter, that inlet temperature can be below 40 degrees F, which means that the water temp must be increased by at least 80 degrees F; however, you are in the warmest part of the U.S. and your groundwater is close to 80 degrees F already, which means that you only need to use about half as much energy to get the water up to 120 degrees F. And, since your water heater is located inside the living space, the standby losses will be less than someone like me who lives in a place that can approach freezing in winter and has a water heater in an unheated space.

4. It's true that water heaters can lose efficiency over time, particularly if you have hard water and you get mineral scaling building up on the heating elements. However, it's quite simple to replace the heating elements and rejuvenate your tank for not much money: Heating element replacement

5. There's nothing wrong with having an 80 gallon water heater for two people. There are only two of us in my house and ours is 75 gallons. And when two of us take showers, one after the other, we start to run out of hot water.

What I recommend is you look at what the energy efficiency label says on your existing tank about annual operating costs, and compare it to the label on a couple of possible replacement tanks. Then compare the amount of annual savings to the total cost of replacing your existing tank now to see how many years (or decades) it will take to break even.

I'm not saying that your plumber is lying to you, but he does have a financial incentive to convince you that there will be big savings to switch out your tank soon. My advice is to wait until the old tank fails and and then get a new, efficient one. How big will depend on your lifestyle, and how long your shower runs daily. If you never run out of hot water, you could certainly downsize some, but don't end up decreasing it by a huge amount or you may end up unhappy.

I agree with Kudzu on most points. A standard electric tank heater isn't going to change much in efficiency -- the new ones might have a little better insulation but not much gain there. You could go with a 50 gal and you would probably be fine for 2 people. Forget electric tankless - they don't get you much in terms of efficiency anyway.

The one possibility is a hybrid heat pump water heater. These take the heat from the surrounding air - and have the lowest operating costs of any water heater including gas tankless. That said, they require air circulation and they also make a little bit of noise. Some, like the one in the link, have a way to attach a duct pipe (to vent to another room). It could be something that would work if you could easily vent it to a larger room. Payback would be really fast and in your state there may be significant utility rebates.

Where I have a different viewpoint is on proactive replacement. This isn't one of those things that you wait until it breaks to fix it. This is more like the tires on your car where a failure can be, at minimum, a big hassle. A water heater tank opening up in a basement can suck. Having it happen in an apartment really sucks unless it all goes in the pan. Even then you have to deal with the unplanned event (and usually after hours or on weekends). Just replace it.

BTW: I live in the midwest where we are still having snow! I'm willing to provide free in-person consulting services with a two week minimum - you provide the housing. : )

When we lived in a townhouse in Hawaii we also had an electric water heater. I used an external insulation blanket to improve the insulation, and then added a 240 volt timer/switch.

We had the timer setup so that the heater was on for about 2 hours in the morning when we were getting ready for work, and about 2 hours in the evening when we were cooking and doing dishes. That schedule even worked on weekends, since the extra insulation made the heater cool very slowly when it was shut off.

Bruce