Making Sense of Property Deductibles

One of the two most frequent questions I get asked when it comes property or auto insurance is, “what deductible should I use” and “what will happen to the premium if I raise or lower my deductible?”  Both are great questions, but first I think it is important to explain what a property deductible is and why they are used.

What is a deductible?

A deductible is the amount of money that you (the insured) would pay first out of pocket before an insurance company would begin payment for a claim.  Deductibles usually occur in property and auto insurance, but can be found in some liability and workers compensation policies.

Let pretend you had a tree that was struck by lightning near your home.  The tree fell over and smashed into the side of your home causing $5,000 in damage.  On your homeowners policy you carry a $1,000 deductible.  In this scenario, you would pay the first $1,000 and the insurance company would pay the remainder of the cost.

Why Deductibles?

The main reason insurance companies use deductibles is cost containment.  Obviously by making an insured pay for the first $250, $500, $1,000 etc. for every claim, the insurance company is unlikely to pay small claims that add up.  This also can help the insured by keeping premiums lower.  The higher the deductible, the lower the premium in most cases.  In the long run, this can help keep premiums lower for both the insured and the insurance company.

How do I choose the right deductible?

Selecting the correct deductible is not a perfect science.  It depends on your current situation, risk tolerance, and how much the premium fluctuates per deductible.  It also depends which line of insurance you are insuring (auto, home, business). This is why it is important to discuss this with your agent so that can make sure you are selecting deductibles that work best for you. A large business owner with large assets is in a much different situation than a struggling homeowner just trying to make ends meet.

I have worked with business owners who have used a $10,000 property deductible and individuals who have used $100 and $250 deductibles.  It’s a matter of perspective and doing what’s best for your specific situation.

Cost Benefit and Risk Tolerance

Let’s say that I am working with a  homeowner who is struggling to make ends meet.  They have only $500 in savings.  It wouldn’t make sense to put a $1,000 deductible vs. a $500 deductible on their home insurance even if it is saved them $50/year in premium.  First, it would take 10 years to make up the difference in premium cost for one claim.  More importantly, should they have a claim, a $1,000 deductible would put them in a horrible financial situation.  This often gets overlooked.  Between this homeowner’s low risk tolerance the low cost benefit, it would make no sense to put them in a higher deductible.

Contrast this to a homeowner with $15,000 of savings in the bank.  They may look at a deductible of $1,000 or higher.  Lets say that this homeowner is comparing $500 and $2,500 deductibles.  The annual premium difference between these two deductible options is $250.  In this example, it would take eight years for them to “break even” if they had one claim that exceeded their deductible.  This may still seem like a long time, however, their risk tolerance is very high and they are only worried about a catastrophic loss.  It very well may make sense for this homeowner to go to a higher deductible.

The most important thing is that you understand your options and make the best decisions for your situation.  As with all insurance policies, one size does not fit all.

How much money should you be willing to pay for your property deductible?

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