Why Do Insurance Deductibles Exist?

Posted on August 13, 2021

An essential aspect of any insurance policy: the deductible.

Chances are you've heard the term, or even potentially had to pay one. But you may be asking yourself: why do deductibles exist?

It may seem redundant, insurance companies are expecting you to pay a part of the claim? Isn’t that what your premium is for?

Well, yes and no. The main purpose of deductibles is to keep the cost of insurance low and affordable for everyone. Your premium is the cost of having your plan or policy.

To understand why there are deductibles, it's important to first understand what they are in the first place.

What Is an Insurance Deductible?

Simply put, a deductible is an amount that you will pay out-of-pocket on a claim before the insurance company steps in and pays the remainder of what is owed.

This is the amount that you agree to have deducted from your final claim payout. Usually, they are a set dollar amount but in some cases, they can be a percentage of the amount of your policy.

Sample Situation

So, let's say that you're in an auto accident and there is $2,500 in damages. If you have a $500 deductible, your insurer will cover the remaining $2,000 after your initial payment.

Or maybe a giant storm rolls through and your home has flooded. If you have a 3% home insurance deductible and your home is insured for $100,000, your final expense would be $3,000, regardless of the claim size.

Perhaps you have a dental insurance policy for your family. In these cases, it's often an annual deductible instead of a deductible per claim. If you have a $500 annual deductible, your full benefits would begin once you had paid a total of $500 in that calendar year, regardless of the number of visits.

Preventing Fraud and Minor Claims

A critical component of deductibles is the idea that they distribute risk across the policyholder and the insurance company. No one party is liable for the entire cost.

Because the individual filing the claim will be responsible for a portion of the payment, it significantly reduces the chances of fraudulent filings. A scammer may not be as eager to submit a false claim if they have personal interests at stake.

Especially for policies with high deductibles, the claim amount would need to be substantial to justify filing for it. Can you imagine what would happen if people were able to file auto insurance claims for every nick, dent, or scratch on their vehicle?

Claims take a hefty amount of resources to process regardless of their size. But thousands of additional claims would mean there would need to be thousands of additional employees too -- those costs would add up quick!

Having a deductible makes the individual responsible for the cost of minor damages or claims. If an owner of a vehicle has a $250 deductible, they likely will not go through the claims process unless they have significant damage, probably of $500 or greater.

If an event occurs that may warrant utilizing your insurance, use your best judgement, or follow this advice about whether or not to make a claim

How Do Deductibles Affect Your Premiums?

Having a deductible as part of your insurance policy is not a bad thing! By minimizing both minor and fraudulent claims, the insurance companies can preserve valuable resources, such as staffing and capital.

In return, insurance companies are able to pass that cost savings directly back to you, the customer, in the form of lower premiums.

Do All Insurance Policies Have Deductibles?

Not all, but most medical, homeowners, and auto insurance policies have some form of deductible in place.

Other types of insurance, like travellers or life insurance, may not have a deductible, but often have other qualifying events that need to occur in order to qualify for a payout. 

Before purchasing an insurance policy, be sure to read the terms and details so that you know if you have a deductible, and if so, how much it would be for. Don't take this decision lightly! The trade-off is that higher deductibles commonly have lower insurance premiums.

Is a Higher Deductible Better?

Depending on your risk factors, policy, and financial situation, there may be multiple options for your insurance deductible amount.

Your deductible is the amount that you would be willing to pay out of pocket for every claim. While a $2,000 deductible for your insurance may keep your premium low, you will be on the hook for each claim below that threshold. So if you find yourself needing a couple of $500 claims, you would be responsible for paying those out-of-pocket.

When selecting your deductible rate, be sure that you understand your policy and all that it entails. Make sure your deductible is an amount that you can comfortably afford, though. You never know when you may need to file a claim. 

As a basic rule of thumb, if you are generally healthy, a safe driver, or otherwise at low risk for filing a claim, then a higher deductible may be best suited for your needs.

Be sure to weigh the pros and cons based on your unique situation!

Are All Deductibles the Same Amount?

In some cases, deductible amounts vary based on coverage amounts -- even under the same policy.

Take for example your auto insurance policy. Based on the options you chose to cover, your deductible can vary from claim to claim. You may have a $250 deductible for your comprehensive coverage, but a $500 deductible for your collision coverage.

What this means is that if a tree falls on your car during a storm causing $750 in damages, you would only be required to pay $250 to get your vehicle back to looking brand new.

If that same amount of damage is caused by hitting another vehicle, though, you'd be on the hook for the first $500, and then your insurance coverage would kick in.

Will You Always Have to Pay a Deductible?

In most cases, yes. You need to meet your deductible before any payout or coverage comes into effect.

This means that every time you file a claim, you must ensure that you have reached the deductible amount to receive benefits. Any amount below the deductible threshold is up to the individual to cover. In most cases, you will pay your deductible amount for every claim.

Some policies, however, offer $0 deductibles, or the option to have your deductible waived if you are deemed to be not at fault.

Types of Insurance Deductibles

Chances are that you're going to be faced with a lot of options when selecting your insurance -- the amount for your deductible being one of them. When you compare insurance providers, you'll have to take into account their premiums, coverage amounts, and the amount that you will be liable for.

This decision also varies based on the type of insurance you plan to purchase. There are some useful checklists to help you determine what kind of insurance you should consider purchasing.   

It’s important to note that not all deductibles are built the same. In fact, you may come across a few other deductible formats.

Disappearing Deductible

The disappearing deductible, often found in auto insurance policies, is a reward for being a lower-risk individual. Oftentimes policies will provide a discount on an individual's deductible if they are "accident-free" for a specified period of time. 

Less risk means fewer claims, which equates to more savings for the insured! 

Aggregate Deductible

An aggregate deductible is a maximum that a policyholder can pay out-of-pocket over a specific period, usually annually. This is commonly used for policies where there is a predicted high frequency of claims or losses. 

Usually, this is found in medical or dental policies, where you will be responsible for a specified amount per year to pay. Once that limit is reached, the insurance policy will pay the remaining loss amount for the remainder of the period. 

Franchise Deductible

A franchise deductible is the minimum amount of loss that must occur before policy coverage sets in. This differs from ordinary deductibles because once this threshold is met, the entire loss amount is paid out to the insured, subject to the limit of the policy.

How Do I Pick the Right Deductible for Me?

So, why do deductibles exist? Hopefully, by now, you have a better understanding. Whether it's for the distribution of risk, minimizing fraud, or keeping premiums low, insurance deductibles exist to save customers money and sharing liability.

When examining your potential insurance options, looking at the premium amount alone is not a complete comprehensive picture of your bottom line. There are a multitude of variables to consider; coverage amounts, terms, and deductibles.

By comparing insurance quotes through Insurdinary, you’ll be able to see a breakdown of just what you’ll be getting—and what you’ll be saving as well!

We minimize the guesswork; in just a few brief minutes you’ll have a clear view of the insurance policies available to you. Best of all? It’s fast, simple and free!

Next Post:
linkedin facebook pinterest youtube rss twitter instagram facebook-blank rss-blank linkedin-blank pinterest youtube twitter instagram