Why do insurance companies have deductibles?

Insurance Q&A: “Why do insurance companies have deductibles?”

Not a bad question. After all, we pay insurance premiums so the insurance company will take care of us in the event we have a property damage claim on our homeowner’s insurance policy or physical damage to our vehicle.

What gives with taking our hard earned money when something actually goes wrong? We know it’s splitting hairs, but for the record, you don’t actually “pay” a deductible.

The insurance deductible is just the amount of money subtracted from the actual damages paid by the insurer.

For example, if someone dents your car in a parking lot and takes off without leaving a note, you’d have to report it to your car insurance company.

After getting an estimate, you may be told it’ll cost $2,000 for repairs, so after your $500 deductible, you’d be given a $1,500 check.

If you can get the damages repaired with just that amount (or less than) the insurer pays out, more power to you.

Okay, I May Not Actually Pay the Deductible, But What Gives?

Ultimately, there are a couple of reasons for the insurance deductible on a policy that covers property damage.

For the record, there can be a deductible on liability insurance claims as well, but that deductible is usually reserved for commercial insurance policies.

First, there are the “moral” and “morale” hazards an insurance policy may present.

The second reason is to limit “nickel and dime” insurance claims that would significantly drive up everyone’s insurance rates.

Moral and Morale Hazards

A moral hazard is situation or circumstance that might cause a person to do something immoral to realize any sort of benefit (in this case a financial one).

An example of a moral hazard may be an individual who decides they would rather have their car “stolen” or otherwise destroyed, rather than pay off a loan they took out to pay for it.

With a deductible, that person would be left on the hook for a pre-determined amount of money, which may cause them to think twice about throwing it off a cliff!

An example of a morale hazard may be the person who leaves the keys in their car overnight because, “the insurance company will buy me a new one if it’s stolen.”

Or, not trimming tree limbs that overhang their home because, “the insurance company will replace my roof if it’s damaged by the tree.”

With the deductible in place, you may think twice about allowing either of the situations to occur.

The insured essentially has “skin in the game,” and may be on the hook for paying a few bucks as well, in the event a loss occurs.

I Would Like to File a Claim for a Rock Chip on My Car’s Hood

We know…shocking, right? Believe it or not, without a deductible on an insurance policy, some people would file claims for a $5 door ding caused by a shopping cart. Who cares, right? It’s five bucks…pay it.

Well, an insurance company isn’t on the hook for only five dollars. The expense of investigating and paying a claim exceeds the five dollars by a long shot.

The person who “takes” the claim over the phone and the claims adjuster both have salary and benefits that need to be paid for them to show up to work.

With a deductible, we are all responsible for the minor damages we incur as a result of owning property. You think you’re paying too much for insurance right now?

Imagine if your premium had to cover the cost of another million or so claims to be adjusted and paid out. We’d all be sorry. (For more information, read our “What happens to an insurance premium when a deductible is lowered?“)