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Common Insurance Terms – Deductible

January 10, 2012

Continuing in common insurance terms, today’s blog is on deductibles.  Most insurance policies have a deductible clause which can be described as “A portion of a covered loss that is not paid by the insurer.”  Deductibles vary by policy and fall into two broad categories: a per event basis (each claim, each occurrence, etc.) or on an aggregate basis (all losses until the deductible is met). For instance, each time your teenager backs the car into a wall, the per event deductible on your auto policy will apply.  On the other hand, every time your teenager hurts himself after walking into a wall, the health insurer will only pay after your out-of-pocket deductible has been met.

Regardless of the amount or type, deductibles accomplish several things:

Reduce Moral Hazards  – This is a simple way of saying the insured has some skin in the game.  If there is no consequence for a risk, there’s no incentive to guard against it.

Reduce Premium – Since the deductible amount reduces the amount a policy pays, it follows that less premium needs to be collected.  Due to the costs of administering and settling claims there is not a one-to-one dollar relationship between deductible amount and premium size.  A general rule of thumb: the higher the deductible the lower the premium.

Selecting the deductible size is a personal decision and based on the level of risk assumption you are willing to take.  It is important to objectively evaluate premium reduction vs. increased deductible.  Consider a scenario where a $200 premium reduction increases the deductible by $1,500 for each and every claim — not necessary a good trade.  When in doubt follow the old insurance maxim, “Don’t risk a lot to save a little.”

As always, for a comprehensive list of insurance terms we recommend you visit the International Risk Management Institute (IRMI).

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