Share This Article
When purchasing either property insurance, automotive insurance, or health insurance, one of the terms you’ll inevitably come across is a deductible. Although the term itself sounds straightforward enough, lacking an extensive knowledge of how deductibles actually work can often spell huge trouble down the road. To clarify things right away, an insurance deductible is the exact amount of money you are contractually obliged to pay out of pocket before your insurance company kicks in and pays for the rest of the covered expenses.
Knowing how your deductible works, what its connection to your premiums is, and how the industries regulate this out-of-pocket expense is vital for maintaining your household’s budget. By getting rid of the industry jargon, you’ll be able to master your insurance policy and make informed decisions when choosing your coverage.
How Do Insurance Deductibles Work?
The best way to explain the mechanism behind a deductible is to use an actual life scenario. Imagine that you are coming home on a rainy night, slip on the road, and strike a guardrail. As a result, you sustain $6,000 worth of damage to your car’s chassis. Assuming that your automotive insurance policy features a standard collision deductible clause of $1,000, you will be required to cover the first thousand dollars of the repair costs personally, and your insurance carrier will take care of the rest ($6,000-$1,000=$5,000).
A widespread misunderstanding is that the policyholder needs to cut a check to their insurer before any repairs can be done. In fact, all the carrier does is simply subtract your deductible from the total amount of money issued to you. Using the scenario from above, the insurer will issue you a check for $5,000 worth of repairs ($6,000 in total damage minus your deductible). You will be required to pay for the rest $1,000 worth of repairs yourself out of your personal bank account to cover the balance.
Flat Dollar Deductibles vs. Percentage Deductibles
Depending on where you live, your insurance provider, and what kind of asset you need to protect, your deductible will likely be regulated in one of two distinct ways.
Flat Dollar Deductibles
This is the simplest and the most traditional form of deductibles. A flat dollar deductible is a fixed, prearranged amount of money specified on your insurance policy’s declaration page. Typical dollar amounts range from $500 to $2,500. Regardless of the size of the actual claim, your deductible will remain constant and fixed.
Percentage Deductibles
These kinds of deductibles are more complicated, and they are most common in homeowners’ policies in areas of the country that are prone to severe weather conditions such as hurricanes, tornadoes, hail storms, and wildfires. The key difference from the flat dollar model is that a percentage deductible is calculated based on the total dwelling coverage (replacement cost) instead of the total damage. Let us suppose that your home’s structure is insured for a total replacement cost of $400,000 and your homeowners’ insurance policy features a windstorm deductible of 2%. Your out-of-pocket costs for a storm claim would be $8,000 ($400,000 x 0.02). Whether the storm damaged your roof for $12,000 or for $120,000, you are going to be expected to cover the first $8,000 out of your pocket. As you can see, these amounts may easily skyrocket, so reading the fine print on your policy is vital in areas with high weather risks.
What Is the Relationship Between Your Deductible and Your Premium?
There is a direct correlation between the two that works in reverse. The better you understand how it works, the easier it will become to personalize your insurance policy to suit your needs.
If you decide to go with a low deductible, say $250 or $500, you essentially pass all the risks associated with the claim payment to the insurance company. Since they are now on the hook for most of the payment, the carrier will be more likely to increase your regular premium, which is the amount of money you have to pay regularly to maintain your coverage.
On the other hand, if you choose to set your deductible at a high point ($2,500 or $5,000), you are ready to take on the initial risk of covering the damage yourself. The insurance company takes much less financial exposure, and, therefore, they offer you a reduced premium as a reward.
For people who are trying to reduce their overall insurance-related expenses as much as possible, picking a high deductible is the best solution to the problem. However, you must be sure that you have that exact amount of money saved in a highly liquid emergency fund to prevent a cash flow shortage.
Per-Incident Deductibles vs. Annual Deductibles
The final point of confusion for many customers is related to the frequency of deductibles. Depending on the type of insurance policy, the regulation is vastly different. Medical insurance deductibles operate on an annual basis and reset on January 1st every year.
Under the U.S. healthcare system, the deductible resets every year. That is, once the out-of-pocket amount hits a predetermined yearly limit, your policy becomes free of charge for the rest of the year. This is why it is critical to know your out-of-pocket maximum.
In contrast, all other types of policies use a per-incident deductible approach. Thus, every claim you file requires you to pay a certain out-of-pocket expense before receiving any insurance payouts. For instance, suppose that you had an accident in March and needed to repair your roof because of a kitchen fire. In August, another incident occurs and breaks your roof due to a severe hailstorm. According to the policy, you will be expected to pay two separate deductibles for each incident (two hailstorms and two fires in one year).
Conclusion: Setting Up Your Policy Deductible Limit
Although navigating your insurance deductible requirements and limits can be tricky, it doesn’t have to be this way. First of all, when choosing a new policy or reviewing your current insurance coverage during an annual audit, pay attention to the ratio between your household’s monthly cash flows and your liquid savings. People who want to minimize their risks and enjoy consistent monthly bills can pick a lower deductible. For those who are willing to shoulder some additional risk to lower their insurance premium and maximize their savings, raising the deductible is a great way to go. Discuss your options with an agent and make the most informed choice.
FAQs About Insurance Deductibles
Q: What if the estimated repair costs are under my policy deductible?
A: If the total cost of repairing your damaged property by a licensed contractor is $700, and your insurance deductible is $1,000, your insurer won’t provide any payment. The reason being is that all the incurred expenses fall within the deductible. Therefore, you will be expected to repair your property at your own expense. You should also avoid filing a claim for smaller losses since reporting them may ruin your insurance record.
Q: Can an insurance carrier waive my deductible?
A: Under some circumstances, the insurer may agree to waive your deductible requirement. For instance, in cases of severe damage to your home caused by natural disasters like tornadoes, thunderstorms, floods, wildfires, or earthquakes, the total loss far exceeds your policy coverage. If you happen to have total losses with your home’s structure being destroyed, you may not even have to pay a deductible at all.
In the context of automotive insurance, you may notice that some carriers waive your comprehensive deductible if you are filing a windshield chip claim. They are doing this to encourage you to replace the broken glass while it’s still in relatively good condition.
Q: Are there separate deductibles for different types of claims?
A: Yes, in many instances, the same insurance policy may have several different deductibles for various claims. A typical automotive policy would have two distinct deductibles for collision and comprehensive claim payments. Similarly, you can find a standard $1,000 flat dollar deductible for a typical claim and a special 2% or 5% percentage deductible for windstorm, hail, and hurricane damage.
Q: Can I change my deductible anytime I want?
A: Yes, unlike your premium, which is regulated by the insurance company, your deductible can be changed anytime throughout the year. If you wish to increase your deductible, simply contact your agent, and your new insurance plan will be updated immediately. Your insurer will adjust the remaining payments and either send you a refund or reduce your monthly premium statements.