Abstract: The present invention relates to water heater (12) construction whereby thermal insulation material is foamed in the clearance space between the tank and shell of the water heater, wherein the foamed insulation material has lesser uniformity in cell structure and density and a lesser or smaller density in the upper portion of the volume of foam which is disposed over the top of the inner water tank than in the lower portion of the volume of foam insulation material disposed around the side of the inner water tank. The present invention provides gas and electric water heaters with improved energy efficiency, utilizing a liquid, foam-in-place composite foam insulation system. The present invention further provides an improved method for insulating the annular clearance space between an inner water tank and an outer enclosure of a gas or electric water heater.