3 Things You Should Know About Insurance DeductiblesApril 18, 2019
“Deductible” is a word that gets used a lot by professionals within the insurance industry. But, unlike many insurance terms, deductible is also widely used by insurance consumers. For many insurance consumers, deductibles are merely looked at as an amount of money you “pay” your insurance company when a claim occurs. While it may seem like that is what is occurring when a deductible comes into play during a claim settlement, it’s not entirely accurate. Here are a few things you should know about insurance deductibles and how they work both before, and after, a claim:
1. Deductibles Aren’t Paid to Insurance Companies
After a property claim, your insurance company will pay for the replacement of the property that was lost or damaged in the claim less the policy deductible if you have purchased a Replacement Cost valuation provision with your policy. If the property is insured on an Actual Cash Value basis, the cost of new property of “like kind and quality” minus the depreciation realized by the lost property (prior to the loss) will be paid.
For example, if you have a detached garage insured on a Replacement Cost basis with a $1,000 deductible and you have a roof damage claim totaling $2,500, the insurance company will pay $1,500 of the claim. The remaining $1,000 owed to the contractor for the roofing services and materials is your responsibility to pay because that is the deductible amount.
The deductible is, therefore, the amount of a claim that you have agreed to “self-insure” when you purchased your policy. It is not money owed or paid to your insurance company.
2. Higher Deductibles May Provide You With Premium Savings
As a rule, selecting a higher deductible when you purchase your insurance policy will provide you with premium savings. Companies may also surcharge a policy that has a low deductible. At first glance, it may appear that you should always select a higher deductible in order to save premium dollars. However, in some scenarios, it may be wise to take a lower deductible; even if it means paying a higher premium.
Depending on the policy type and the amount of insurance purchased, both the percentage of discount built into the pricing structure of the policy and the amount of potential savings to the consumer can vary, respectively. For example, a large Commercial Insurance policy that insures a large amount of inventory and high-value buildings may create thousands of dollars of savings per year if the policyholder selects a $5,000 deductible.
A large business can likely afford to pay $5,000 of a loss out of pocket and, as such, the ability to save, say, $3,000 per year in premium because they selected a higher deductible makes sense. The company only needs to remain loss-free for 2 policy periods before they are “money-ahead”. Even if a loss occurs in year 3 and they must pay for $5,000 of the claim amount, they have already saved a total of $6,000 in premium over the last two years.
To the contrary, a homeowner with a house of average cost to rebuild may be better served by selecting a lower deductible. The reason for this is because the pricing difference between a $250 deductible and a $1,000 deductible may be as little as $25. A homeowner needs to save $25 per year for 30 years, without any claims, in order for the selection of the higher deductible to garner enough premium savings to be financially beneficial to them.
3. Deductibles are Designed so Everyone has “Skin in the Game”
A common question from insurance buyers is “Why do I need to pay my deductible after I’ve already spent all this money on an insurance policy?” There are multiple answers to that question and most are multi-faceted. However, simply put, deductibles are an important part of an insurance policy because they encourage and incentivize responsible property ownership.
By having “skin in the game”, it is in both the policyholder’s and the insurance company’s best interests to ensure that appropriate property maintenance occurs and is sustained throughout the duration of the contractual agreement between the two parties. If a policy was written to cover property on a Replacement Cost valuation basis and had a “zero” deductible, there would be an inherent lack of incentive on the policyholder’s part to maintain or update the insured property because, if a loss were to occur, the policy would pay from dollar one and they would receive “new for old” due to the Replacement Cost provision on their policy.
Zero deductible policies do exist, but they are typically seen within auto insurance products and are usually limited to the Comprehensive line of coverage. Additionally, vehicles are valuated on an Actual Cash Value basis instead of Replacement Cost; with a small exception to that rule being policies that offer Replacement Cost on vehicles that are only a few years old.
Deductibles, by their nature, also allow insurance companies to avoid small, maintenance types of losses that can and should be avoided with diligent property management practices. Small losses, with total damages coming in under a policy deductible, create a less onerous financial burden to the property owner and, as such, are better managed through regular maintenance initiatives.
As mentioned above, in consideration for avoiding payment of these small types of claims, insurance companies incentivize the selection of higher deductibles with premium discounts that they give back to the policyholder.
Deductibles are a well-known part of insurance policies, but they are often misunderstood. However, they also aren’t as complicated as they may seem at first glance. The most important thing to keep in mind is how your deductible selection impacts your premium and how it may also impact your cash flow if you incur a loss.
The combination of the potential savings you may be able to receive, paired with your own unique and individual financial picture, will point you in the right direction when it comes to choosing a policy deductible.
An experienced, licensed insurance agent can help walk you through this aspect of the insurance buying process and help to explain the available options. If you need assistance in choosing the right policy, with the right deductible, give one of our agents a call at 717-665-2283!
Disclaimer: Information and claims presented in this content are meant for informative, illustrative purposes and should not be considered legally binding.