The insurance deductible is an often misunderstood tool in insurance. Set it too low, and you will see a premium increase. Too high, and you’ll often wonder, “Why do I buy insurance if I’m never going to use?” We explain to our clients that the insurance deductible is a kind of “ownership” for an accident or a claim. A way of the person responsible for the property to lose a little bit in order for the insurance company to start to pay the rest of the loss.
Formally, our manuals define an insurance deductible as:
An amount of money previously agreed upon that the insured or client will need to pay in order for a claim made against an insurance policy.
So how does one “agree” upon an amount of deductible and how might this be used in a claim? Hang tight. It might get a little “mathy.”
We have always advocated that an insurance deductible should sting a little bit when you use it. We can go down the road of “risk tolerance” in a future post but essentially; how much can you afford to pay, but would still feel reluctant to pay, if you had to? For an 80,000 dollar car of an executive in her 50’s, that amount may be 2,500 dollars or more. For a retiree living off of fixed income, that desired deductible amount may be 500 dollars. It really should vary by the person because everyone is a little more or less inclined to risk their money and the insurance deductible is designed to work that way. Too low of a deductible and the insurance company knows you will turn in every little claim that ever occurs because you can push it off to their wallet for a small amount. Additionally, the industry also knows that the more claims you report, the higher likelihood that you are going to have a large insurance claim in the future.
Let’s take our two deductibles above and say both of these insureds have their vehicles keyed in the parking lot at the mall. Both cars sustain $1,500 in damage, and both insureds call in to file a claim. Our 50-year-old executive finds out that she set her deductible to 2,500 dollars so the claim of $1,500 would be silly to turn in since she would be paying more to file the claim than if she had just chosen to pay the repair bill herself. Our second insured set her deductible to $500, and the $1,500 in damage is well and above her deductible. She files the claim, pays her deductible of $500, and the insurance company picks up the remaining $1,000.
So who won here? That’s difficult to say because of other factors, but it is truly a function of how much risk are you willing to bear. Insured #2 could be paying twice as much for insurance to carry that low of a deductible. She could also see a rate increase if she frequently turns in more claims. Remember, claims will usually stay on your insurance record for 3-5 years in the case of auto insurance. Our insured #1 is out $1,500 from her pocket, but her insurance claims record is kept clean. She will see no rate increases because of filed claims, and she will continue to pay a lower premium for insurance because the insurance company recognizes that she is willing to take on more responsibility for her actions or property.
In closing, if you are someone who is very unlikely to turn in a claim, raise your deductibles and take the savings now. Use insurance for “the big stuff.” Counter to this, If you are someone who is accident prone or an accident could leave you in financial ruin, perhaps a higher deductible is a smarter move for your insurance portfolio.