Deductibles
Most insurance policies are written with some form of deductibles. A
"deductible" is a specified amount deducted from the total loss amount
that otherwise would be payable. The insured is expected to absorb the
initial amount equal to the deductible in case of a covered loss. The
insurance carrier is called upon to pay out the excess of the deductibles.
Deductible provisions are typically found in property, health, and
automobile insurance policy agreements. Deductibles generally are not
used in personal liability insurance because the insurer must provide a
legal defense, even for a small claim. The insurance carrier wants to be
involved from the first dollar of loss in order to minimize its ultimate liability
for a claim.
Collision and Comprehensive policies may be written with a $250 or
higher deductible. It is recommended that consumers carry the highest
deductibles he can afford in case of an accident on comprehensive and
collision insurance. Increasing the deductible from $500 to $1,000 will
reduce the collision and comprehensive insurance premium from most
insurers by 10% to 15%.
Purposes of Deductibles
Deductibles serve very important purposes:
 | eliminate small claims; | |
| lower premiums for consumers; and | |
| reduce moral and morale hazard. |
Eliminating small claims. A deductible eliminates small claims that are
insurer could easily incur expenses of $500 to process a $100 claim.
Since deductibles eliminate all small claims, the insurance company's
operating expenses to process claims are reduced to a minimum.
Reducing premiums. Since small losses are eliminated, more of the
premium dollar can be used for the more serious claims that can cause
serious financial disability if a loss should occur. Insurance is not a good
invention for paying small losses that merely inconvenient the insured and
that can be overcome with better financial budgeting. Insurance should
be used to cover large catastrophic events, events that ruin lives and
business establishments if not make whole with insurance. Insurance
that protects against a catastrophic loss can be afforded more
economically when deductibles are used.
Other factors being equal, a policy with a large deductible is preferable to
one with a small deductible. For example, consider an automobile collision
insurance policy with a $500 deductible in NYC costs $2,002, and the
same policy with $1,000 deductible costs $1,885. If a motorist chooses
the $500 deductible, he receives an additional $500 in coverage, but pays
an additional $117 in annual premiums. Applying a simple cost/benefit
analysis, $117 in premiums for $500 of insurance is a very expensive
increment of insurance. When analyzed in this manner, large deductibles
are always preferable to smaller ones.
Reduce moral and morale hazard. Crooks have been known to
deliberately cause a loss in order to profit from insurance. Deductibles
reduce such moral hazard by reducing and in some cases eliminating the
profitability of this type of fraudulent claims.
Deductibles are also used to reduce morale hazard. Morale hazard is an
insured' state of mind of carelessness due to having insurance in force.
Deductibles encourage insureds to make an effort to avoid and prevent
losses, since insureds must pay part of any loss.
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