An insurance deductible is one of the major out-of-pocket expenses associated with an insurance policy. This is the amount that policyholders must pay out for an insured loss before coverage starts.
Understanding how deductibles work is crucial in helping individuals and businesses get the most out of their policies. To shed light on this essential insurance component, Insurance Business explains the role an insurance deductible plays in providing coverage, how it differs between policies, and its impact on premiums. Industry professionals can share this article with their clients to give them a firm grasp of this important element of an insurance policy.
An essential part of an insurance contract, a deductible is the amount the policyholder agrees to pay out of pocket before the insurer shoulders the cost of coverage.
One important thing to note, however, is that although it is common in the industry to hear “after paying for a deductible,” most of the time, policyholders do not actually pay anything to their insurance providers. Rather, they pay for something equal to the deductible amount – car repairs or medical tests, for example – then the insurer pays out for the rest of the coverage up to the maximum limit.
In some instances, insurance companies subtract or deduct – hence the term deductible – the amount from the insured loss before paying out up to the limits of the policy.
You can check out the meaning of common insurance industry terms in our jargon buster.
Because they share the cost of the claims with the policyholders, insurance providers can avoid receiving a barrage of small and inexpensive claims, so they can focus on major losses, which insurance policies are designed for.
In a way, having deductibles can also make policyholders think twice about engaging in risky behaviors or not acting in good faith as they will be financially impacted by any loss or damage as well. This effectively aligns the interest of the insured with that of the insurer, which is to mitigate the risk of major losses.
There are two ways how insurers impose deductibles in an insurance policy:
The deductible amount is indicated in the terms of coverage on the declarations page, or the first page, of an insurance contract.
According to Triple-I, state insurance regulations strictly dictate the way deductibles are incorporated into the policy’s language and how these are implemented, although laws can vary between states.
Almost all insurance policies come with a deductible, except for life insurance, where the beneficiaries receive a tax-free lump-sum payment after the policyholder dies.
Read more: What is life insurance and how does it work?
A single policy may also have multiple deductibles as each coverage may have its own deductible amount. The only exception is health insurance, where plan holders usually need to meet a single deductible for an entire calendar year.
Here’s how insurance deductibles work for the different types of insurance policies.
In home insurance, deductibles apply only to property damage. Homeowners do not need to pay a deductible for liability claims. The deductible also applies each time a claim is filed.
For policies with standard or dollar-amount deductible, the deductions work pretty straightforward – the amount specified in the contract will be subtracted from the claims payout. If a policy has a $500 deductible, for instance, then the insurer will pay the policyholder $9,500 for an insured loss worth $10,000.
For plans with a percentage-based deductible, the amount the insurance company covers is calculated based on a percentage of the property’s insured value indicated in the policy document. For homes insured for $250,000 with a 2% deductible, for example, the insurer will send the homeowner a claims check for $24,500. Percentage deductibles generally apply only to home insurance policies, and not to other types of plans.
While standard homeowners’ insurance policies cover wind, hail, storm, and hurricane damage, protection against certain types of calamities – including flooding and earthquake – must be purchased separately.
Many home insurance plans come with special deductibles – also referred to as disaster deductibles – that apply to claims attributable to different natural calamities. Here’s how they work:
These deductibles work almost the same way as those for home insurance, except that percentage-based deductibles do not apply. Policyholders also pay deductibles only for vehicle damage and not for liability claims.
Generally, car insurers allow motorists to choose separate deductibles for collision and comprehensive coverage, even if they have the same amount.
A disappearing deductible – also referred to as a diminishing or vanishing deductible – is an additional coverage in an auto insurance policy that decreases the deductible amount each year that the policyholder maintains a clean driving record. It is also a way for car insurance companies to reward safe drivers.
For each accident- and claims-free year, a motorist can earn certain disappearing deductible credits, which can accumulate and be used to reduce the deductible amount of their collision and comprehensive policies. It is also possible for drivers to reach $0 deductibles if they maintain a clean driving record long enough.
The credits typically reset once the policyholder makes a claim or is involved in a car accident.
Unlike in home and auto insurance policies where each coverage may have its own deductible amount, health insurance plan holders are required to meet a single deductible for an entire year. After they max out on their deductibles, they will then split the costs with their insurer in a system called coinsurance until they reach their out-of-pocket maximum.
Coinsurance follows a percentage-based model. For example, in a 20%-80% split, the plan holder pays 20% of the healthcare costs while the insurer covers the remaining 80% until the out-of-pocket limit is reached. Once they hit this limit, the insurance company then pays 100% of their healthcare expenses for the rest of the year.
Depending on the health insurance plan, policyholders may have an individual or family deductible, or a combination of the two. An individual deductible applies to plans with single coverage and works the same way described above.
Family deductibles, meanwhile, come in two types:
Premiums and deductibles are two of the major out-of-pocket costs associated with insurance, which is why they may sometimes be confused with one another. While an insurance premium is the amount a policyholder pays in exchange for coverage, a deductible is the amount the insured needs to pay for damages before coverage kicks in.
These two, however, have an inverse relationship. As one increases, the other decreases, so generally the higher the deductible, the lower the insurance premium, and vice versa.
When it comes to insurance policies, is it better to have a higher or lower deductible?
According to some experts, choosing a lower deductible makes sense if the policyholder expects to access coverage more often or if they will not be able to afford large out-of-pocket expenses. These may be because they are exposed to higher levels of risks or have not saved enough for an emergency fund.
Meanwhile, a higher deductible can be a good option for policyholders who do not expect to make a lot of claims. This strategy also enables them to reduce insurance costs and allocate the extra money to their savings.
If you are deciding whether to go for a deductible, think about what works for your current financial state and how much you can tolerate in terms of risks.
Deductible refers to a specified sum agreed upon by you to be paid out-of-pocket, before any insurance cover comes into place. Here are some key factors to keep in mind when making this decision:
Usually, policies with high deductibles have low monthly premiums. If you want lower monthly insurance costs, you might choose a higher deductible. Note though that it will require you to have higher initial costs on a claim basis than other alternatives.
Check whether you have enough financial capabilities in case of loss. Can you confidently meet your deductible with enough savings or an emergency fund? Otherwise, you may need a lower one.
Risk profile is also taken into account by your comfort level. However, if you are risk-avoidant and seek certainty with respect to financial affairs, it may seem reasonable to choose a lower deductible. This translates to higher premiums, but lower expenses when you go for health care.
The type of insurance may affect this decision. For example, in health insurance, it might make sense for a healthy person to have a high deductible because they don’t foresee too many medical expenses.
On the contrary, in the case of auto or homeowners' insurance where chances of accidents or disasters are not predictable, a low deductible would provide greater comfort.
Deductible requirements often differ between insurance companies in the various jurisdictions; different states have their own special rules on insurance regulations. Verify the requirements and limitations in your state concerning a deductible.
Overall, this decision will be influenced by your financial position and the willingness to take risks. Sometimes, the higher deduction means cheaper policies. However, at a time when one needs medical assistance out of pocket, such policy turns costly.
Look for the right balance that complements your finance goals and provides necessary security. Speak with an insurance professional to help find the right option for you.
Deductibles and copays are two different things that work differently in health insurance plans.
After you have made a certain fixed contribution called a deductible, your health coverage will begin to cover the costs.
For example, if your policy has a $1,000 deductible and a doctor charges $2,000 for a medical procedure, you pay $1,000 and the remaining $1,000 will be covered by your plan. The only exemptions are some services with deductible amounts specified in your policy.
Copays are defined as cash payments agreed upon for certain benefits or services. Usually, however, copays don’t count toward reaching your deductible.
These services remain independent in nature, and you have to pay for them unless your deductible has already been met. In addition, most policies have different levels of co-payments associated with distinct services. For instance, if your coverage schedule has $20 copay for a visit to a family doctor and $100 copay for an accident or injury treatment, then that is what you pay according to the covered benefits.
Both deductible and copay are forms of payments for certain healthcare but differ in their goals.
With copay, insurer share cost only once you’ve met certain set amount for certain service with coinsurance. Deductibles apply in a wider sense, for instance, if you have a copay for healthcare services, you may not have met any part of it under the coinsurance model.
It is crucial to review and read your policy carefully to grasp how this aspect works. Not all plans feature the same copay and deductibles policies.
Deductibles do not amount to covering everything. A deductible represents the initial expenses that one covers once their health plan kicks in. It is a cost sharing arrangement involving you and your insurance company.
Here's how it works: For example, your health coverage has $1,500 in deductibles. You must pay 100% of all eligible health care costs until you have reached eligibility point of $1,500. At this point, your insurance does not pay anything for these costs.
When you have spent up all your $1,500 as deductible, your policy proceeds into another level altogether. You start paying some part of it in partnership with your insurer using an arrangement called coinsurance. In coinsurance, you both share the cost of some covered services.
Although you have paid the deductible, this doesn’t mean that you are to receive full coverage for all services and supplies. However, some insurance policies may still require paying a share of costs and/or deny certain treatments or procedures.
You do not get money back from a deductible. A deductible is an up-front amount that you, as the policyholder, must use to cover insurance loss liability before you can begin transferring money towards your policy. This represents a method that you will share with your insurance company a statement of costs incurred and deducted from the total premium paid for insurance.
Here's how it works: If you have an insurance policy with a deductible, such as homeowner's, renter's, or auto insurance, and you have a covered claim, such as a car accident or home damage, you have to pay it the deductible amount comes out of your own pocket. This deductible is a requirement that you must meet for your insurance premium to take effect.
For example, if your policy has a $500 deductible, and you claim a total insured loss of $10,000, you will receive a premium of $9,500. The insurance company deducts $500 invoice, and you're responsible for paying that first $500.
This is to align your financial responsibility with your insurance coverage and encourage policyholders to share the cost of a small loss.
Insurance companies often offer lower rates in recognition of discounts. If you take a higher deductible, you can further reduce premiums. However, while you get a lower rate on fees, you’re also taking on a higher level of financial responsibility in the event of a claim.
In summary, deductions are non-refundable and you don’t get any money back. They represent the portion of a covered loss that you must bear in order for your insurer to cover you.
What about you? Do you prefer a higher or lower insurance deductible? How much deductible amount do you think is right for each insurance plan? Share your thoughts in the comments section below.