What is an insurance deductible?

What is an insurance deductible, and how does it affect your experience with your auto insurance policy?

Simply put, an “insurance deductible” is the amount of money you must pay for an insurance claim, prior to an insurance company paying out any money for your loss or incurred expenses. Some policies have multiple deductibles based on the type of claim you’re filing. For example, you could assign a different deductible for collision and comprehensive claims on an auto policy. In health insurance policies, you’d pay an annual deductible. Since the introduction of the affordable care act, preventative care and some other costs are not subject to a deductible at all.

A deductible is not paid out of pocket to your insurance company. Rather a deductible is deducted from the payout you or your providers receive from the insurance company.

So if you’re owed $25,000, but you’ve got a $1,000 deductible in place on your policy, you’d actually only receive $24,000 when all was said and done. If you were working with a provider, you’d have to pay them the remaining $1,000 in out of pocket costs. Additional costs would be determined by your coinsurance depending on the type of policy.

Why do insurance companies have a deductible?

The purpose of a deductible is to avoid the moral hazard one might present to the insurer if there were no penalty for filing a claim. It’s basically in place to ensure the insured isn’t just filing claims left and right while living a high-risk lifestyle. Any time you file a claim, your rates may also rise later on. The deductible offers an immediate penalty.

Because deductibles exists, you might actually take the time to lock your car doors and house, knowing you’ll have to pay a portion in the event of a claim. In health terms, you might show up to preventative appointments or take other steps to protect your health and avoid major procedures that would lead to a high out of pocket expense.

Typically, a deductible is a flat dollar amount or a percentage of your policy limit, which is agreed upon at the time the policy is issued.

Your deductible options depend on the type of policy you are considering purchasing. A deductible can range from zero to several thousands of dollars.

Tip: The higher the deductible you choose, the lower your premium will be. In other words, the more you are willing to “self-insure,” the less your insurer will charge you for coverage. Just make sure you can afford to pay this set amount. Otherwise, providers may delay servicing your claim.

What deductible options can you expect?

As discussed above, your deductible will vary greatly depending on which type of policy you are looking at.

Home, auto and health insurance policies each offer unique possibilities with regard to your deductible options. Let’s look at some examples of each.

Auto Insurance Deductibles

When shopping for auto insurance, you may be asked to choose a deductible amount for physical damage coverage for your car(s), assuming you don’t purchase a liability-only insurance policy.

Physical damage coverage on your auto policy includes collision and comprehensive, also known as “other than collision” insurance.

[Collision vs. comprehensive coverage]

So if you are found liable (at fault) for damage to another person’s car or injury to another person in an accident, you DO NOT have to pay a deductible.

They’re only paid for physical damage claims for your vehicle, not liability claims.

You can choose a different (or the same) deductible for each of these types of coverage. The deductible you choose will depend on the value of each vehicle and your personal preference.

Common auto insurance deductible options are $250, 500, or $1,000. If you cannot afford to pay your deductible up front, the auto repair company may refuse to order parts or start repairs until you can. Any rental car coverage you qualify for is still limited to the amount listed on your policy. So if you wait too long, you could incur other costs insurance will not cover. The most common collision deductible is $500-$1000. The comprehensive deductible is often the same. (For more information, read our “What is a collision deductible waiver?“)

Tip: The less valuable your vehicle, the lower the deductible you would want to choose. A $1,000 deductible for a $3,000 car doesn’t make sense. Especially if your car is not valuable and gets “totaled.” At that point, paying for collision coverage might not make sense at all.

[Why do car insurance companies total cars?]

The insurance company pays for the cost greater than the deductible to repair your car. If the total cost to repair the damage to your car is less than the deductible, you are responsible for paying for all the repair costs. In addition, your comprehensive claim cannot pay more than your car is worth.

Due to the increase in rates, it probably isn’t a good idea to file a $1,000 claim to fix your dinged bumper regardless of how low your deductible is.

If you have a $500 deductible, you would save $500 upfront, but may lose out on a lot of money in the future by paying higher insurance rates as a result of filing claims (and costing your insurer money).

Example 1: Rick has a $500 deductible for the physical damage coverage for his car. Rick crashes his car into a neighbor’s mailbox causing $3,000 in damage to his car.

Rick would be responsible for paying the first $500 to repair his car. Rick’s insurance company would pay the additional $2,500. It’s important to note that the cost to repair the neighbor’s mailbox would be covered by Rick’s liability coverage.

Example 2: Ray has a $250 deductible for the physical damage coverage for his car. Ray accidentally backs into his neighbor’s mailbox at a slow rate of speed, causing only $100 damage to his car and no damage to the neighbor’s mailbox.

Since Ray’s deductible is $250, he is responsible for all the repair costs associated with the accident. His insurance company would only pay for damage in excess of $250.

Keep in mind that the deductible is paid each time a separate claim is filed. So if you have multiple insurance claims for damage to your car in a single year, you would be responsible for paying multiple deductibles.

Remember, the number of insurance claims you file is held against you in the form of additional cost for insurance in the future.

Also, insurers may sometimes choose to non-renew your policy after the initial policy term is up based on you filing the claims.

Circumstances can vary greatly, but it may be a good idea to pay for small damages to your vehicle with your own money.

Homeowners Insurance Deductibles

Homeowner’s insurance (and dwelling fire) policies are a little different when it comes to deductible options, and they can impose different deductibles for additional coverage such as water backup.

These policies normally have two deductible options. Namely, a deductible for “wind/hail” related damage and “all other perils,” which refers to anything that damages your property other than wind and hail.

The wind/hail deductible may be expressed as a percentage of your home’s insured value.

An example would be a 1% deductible for a $200,000 home. This would result in a $2,000 deductible for property damage associated with a wind storm ($200,000 x 1%).

[Why are wind deductibles more expensive?]

The same policy may have a $1,000 deductible clause for damage caused by anything else. So, if you have a small kitchen fire, you are only “on the hook” for $1,000.

This is because your small kitchen fire will not affect 200 other homes in your area.

Your insurer is not worried about paying out millions of dollars worth of claims all at once, which is certainly the case when a tornado or hail storm affects an entire city.

[See: Tornado insurance]

Tip: As property insurance premiums continue to rise, national chain insurers such as State Farm are mandating higher insurance deductibles in certain states.

Be sure to shop your insurance premium if you insurer demands you opt for a higher deductible. Ultimately, they are “lowering” your insurance costs by not paying as much for covered claims.

Health Insurance Deductibles

Health insurance is a different animal altogether. However, The concept of a deductible is still the same. You pay for a certain amount of service before your insurer coughs up the first dime…nothing new here.

Most health insurance policies contain a deductible in addition to a co-pay and co-insurance.

So, not only do you cover the first “whatever” dollar amount of yearly services, but you also share a percentage of the expenses that exceed your deductible. Under current health insurance law, there is no deductible on many preventative services, but you may pay a co-pay.

You might pay the first $1,000 per calendar year, but also be responsible for 20% of any cost above that deductible up to your out of pocket maximums.

In conclusion, there is almost always a way to save on your insurance premiums. Be sure to shop online each year or visit a local independent insurance agent to discuss your options.

This is especially true if your current insurance agent recommends you raise your deductible to save money on your annual premium. (For more information, read our “What happens to an insurance premium when a deductible is lowered?“)

It’s the same as saying, “I can save you money if you are willing to pay more of your hard earned money in the event of a claim.”

Note: Deductibles are almost never associated with liability claims, rather only property damage. (For more information, read our “Why do insurance companies have deductibles?“).

However, commercial general liability policies can contain a deductible clause for claims made against your company related to liability resulting from your negligence.

(photo: Marcin Wichary)