Insurance Basics: What is a Deductible?
The insurance term, deductible refers to the pre-specified amount a policyholder agrees to pay in a claim before the insurance company pays the remaining balance. It is a type of self-insurance and the more a policyholder accepts as his portion, the lower his premiums will be. Deductibles are common in most personal lines of insurance including auto insurance, homeowners’ insurance, and even health insurance.
The deductible is what you pay before your insurance policy pays a dime. If you had no insurance, you would pay 100% of whatever the bill was from an otherwise covered claim or loss. If you have no deductible, the insurance company pays it all. Most people are somewhere in the middle with a small deductible to keep premium costs down.
A common example is an auto insurance deductible for $500. If you have an at-fault accident and need your car fixed, you pay $500 to the autobody shop and the insurance company pays the rest. Deductibles are common in many types of insurance policies such as home, auto and health.
When You Pay the Deductible
You pay the deductible when you make a claim. You pay premiums based on policy terms, either annually, semi-annually, monthly or quarterly. Your premium is to have the policy. Your deductible is paid when you need the policy. In the event there is a claim on the policy, you pay the deductible and then the insurance company comes in to pay the remainder.
Health insurance does have some additional caveats to how much is paid. It may require the deductible to be completed and then a co-pay kicks in where you still pay some but the insurance company starts to pay a portion. It’s no wonder health insurance has such a bad rap; it is notoriously confusing for most people to understand billing.
How Deductibles Affect Insurance Rates
Deductibles have a direct effect on the insurance premium you pay. The more you assume in self-insurance as the policyholder, the less your premium is because the insurance company has less financial risk. This means if you have a $500 deductible for your car insurance and decide to drop it to $250, you will increase your policy premium because you don’t want to assume the extra $250 of risk in the event of an accident.
What Good Is Insurance Then?
Many policyholders can feel a bit jaded when having to come up with a deductible after an accident or bad event. It’s understandable. Most people don’t make claims very often; when they do, it usually is a pretty bad day. The thought that you have to fork over more cash when you’ve been paying your premium (that has probably gone up and will now there is a claim) is frustrating.
Your deductible should cover the amount you are comfortable with while the insurance company is there to cover bigger claims with bigger financial loss. It’s certainly far from a perfect system. This had resulted in the Vanishing Deductible programs offered by many car insurance companies that rewards clients for no accident history by reducing the deductible.
Types of Insurance Policies
Take a look at how different types of insurance policies use the deductible.
Auto insurance is primarily required to meet state liability requirements to cover other vehicles, property and people if you are at fault in an accident. Unless you have comprehensive or collision elected on the policy, the deductible doesn’t play a role. Claims to repair others’ property or cover their injuries are without a deductible.
Comprehensive coverage protects you from not-at-fault accidents and incidents. Think about the tree falling on your car or someone stealing the car. If you have a $250 deductible, your insurance company will pay the autobody shop to fix the car and you pay the autobody shop $250 directly to recover it. If the car was stolen and not recovered, you get the value less the $250 in a check issued to you (and maybe the finance company).
Keep in mind that if you fix your car through your own insurance company when another person hit you, you will pay the deductible that must get collected from the other insurance company. This sometimes gets sticky and takes time.
A collision deductible pays to repair your car if you are at-fault in an accident and want your car repaired. Remember there is no deductible paid for the other party’s repairs. The collision deductible is more expensive than the comprehensive deductible because the damage is usually less frequent of often with less overall liability.
Homeowners’ insurance deductibles can be a bit frustrating because a loss can be a few hundred dollars or hundreds of thousands. The homeowners’ insurance deductible is selected either as flat dollar value such as $500, $1,000 or even $10,000 or it can be a percentage of the home’s replacement value such as 1%. If the replacement (not market) value is $500,000 then the deductible is $5,000 at 1%.
It seems pretty straightforward until you file a claim. Assume a burglary took $700 of jewelry from your home. If you have a $1,000 deductible, you are out the jewelry and the cost to replace it. Pretty frustrating, right? On the flip side, if the house burned down and you have $200,000 worth or personal property covered as well as the replacement cost of the home, you would get your home rebuilt and $199,000 in a check to replace your belongings.
Health insurance has to be one of the most confusing types of insurance in existence. There is the deductible, the co-payment and co-insurance. Just when you think you got done paying in one stage, there are other areas you are responsible for payment. Health insurance is not inexpensive, even with marketplace subsidies for income. This means you really need to consider the options.
A high-deductible health insurance plan is a health insurance plan that requires you to absorb at least $1,350 as an individual ($2,700 for a family) before insurance kicks in. Sure, you get an annual health check for free. But taking the kids in with a fever, that food poisoning visit to the ER and your husband throwing out his back all cost you 100% of the bill. The reality is $2,700 for a family feels low when there are deductible plans up to $13,300.
Health Insurance Math
Do the math. If you pay $1,800 a month for a family of three, that is $21,600 in annual premium before you even go to the doctor once. Add the $13,300 you have to cover before insurance co-payments kick in, requiring you to pay $34,900 in healthcare insurance and costs. Then co-payments kick in. That’s the other part you are responsible.
A common example of co-payments (“co-pay”) is prescription medication costs. The bill might be $90 and you still have to pay $15 as the co-pay. Eventually, if you go to the doctor enough, you reach your maximum Out-of-Pocket-Costs which is $7,900 for an individual and $15,800 for a family. Yes, the deductible and co-pay counts toward this amount but still, that’s an extra $2,500 for a family.
Claims Increase Policy Premiums
Most claims for auto and homeowners’ insurance will lead to higher premiums at renewal. In some cases, they can lead to policy cancelation. Don’t shoot the messenger. I don’t agree with it but here is why that is important for you. Imaging the burglary where $700 in jewelry was stolen. If your deductible was $500, would you want to file a claim for the extra $200?
You’d want to but is it worth it? Probably not. The amount you’ll pay for insurance with premium increases could be as much as 20% with some carriers. It isn’t the amount of the claim, it’s having a claim. Carriers do their math and watch claim history. Some studies show the first claim in years can lead to multiple claims for much higher values. Insurance companies often hedge their bets on raising rates.
Health insurance doesn’t do this and some auto insurance policies may have a threshold of the value of the claim before it counts against you. Ask these questions before signing up for a policy.
Should I Choose a High Deductible?
Because small claims can lead to increases in premium, policyholders can become discouraged to file a claim. After all, getting $200 to later pay an extra $300 annually for three years isn’t exactly working in your favor. This is why raising the deductible is often considered. A higher deductible shouldn’t be an automatic solution for everyone.
Consider the auto insurance deductible. If the policy savings between $500 and $1,000 makes sense to you, then raise the deductible. But you need to have that $1,000 available to be able to fix your car. What would you do if you didn’t have a car to drive? Again, do the math because the difference in premium between a $1,000 and $2,000 auto collision deductible is usually not worth it.
Old Cars Don’t Mean Lower Premium
One of the most frustrating things for auto insurance policyholders is seeing comprehensive and collision premiums not decrease with an older car. After all, the value of the car is going down. It dramatically drops the second it is driven off the lot. The reason for this is parts and labor as well as the likelihood of an incident.
What do I mean by that?
Some older cars have parts not as prevalent to find than other newer cars. It might also be harder to find reasonable labor qualified to fix it. That factors into the cost. Cars likely to be stolen for parts are also rated higher than others. Again, this is all the numbers games of insurance companies mitigating their financial risk.
It is also becoming more common for cars to be totaled out even with what seems like minimal damage. The same reasons apply. Cars are designed to crumple at impact leading to a lot of costly damage in places we often don’t see. Even bumper replacement might be $5,000 or more on a reasonably newer car. If it costs the insurance company less to total it out, they will.
Final Thoughts on Insurance Deductibles
The deductible game with insurance sucks. When you have a loss, chances are you are already having a really back day. Finding out you need to open your wallet to fork over more cash for repairs or replacement only multiply your emotions. Take the time to think about this before you choose a deductible. Do the math and make sure you have the assets or resources to cover the deductible in the event of a claim.