Scenario: I pay X amount of dollars per month for car insurance. I have all 4 tires stolen from my vehicle overnight. I submit a claim with my insurance company to repair any damages. I now pay a **hefty** X amount of dollars for the event that has occurred.
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Call you agent and ask for the difference in premiums for $100 deductible, $500, and $1,000. At that point it might be obvious
**Think of insurance coverage like a circle**, with higher cost items at the outer part of the circle, and cheap things near the centre.
A bigger circle is more expensive (Because it provides more coverage).
That’s good in terms of protection – it stops really high costs from bankrupting you.
But those high cost problems are rare. It’s small issues that might cost a thousand dollars or less – but which you can more easily cover the cost of – that are common, and from the insurance company’s perspective they still require manpower and repair shops to fix, so it makes their premiums more expensive.
**A deductible turns that circle into a donut** – the coverage doesn’t start until above a certain cost, so you can basically pay less for insurance (because the insurance company doesn’t have to worry about covering those cheap, but frequent, problems), whilst still having the same coverage for bigger issues that would have been more expensive (but are also less likely to occur).
By increasing the “hole” in the donut, you can reduce your premium – but that also reduces the coverage of next-cheapest issues, so you need to make sure you can afford them.
It’s why deductibles are usually offered with some flexibility – so people can adjust the size of the “donut hole” to suit their needs and budget.
Primarily, to keep one from filing trivial claims. $1,000 deductible means you’re not going to file a claim for a $50 dent or a stolen hubcap.
Equally important to you, the insured, it keeps your cost down, because of reason 1.
A deductible isn’t a charge or fee, it’s the limit you set for yourself on the amount you can reasonably cover toward a loss. In life, most people have big expensive things that they cannot buy or fix casually or spontaneously. They had to plan carefully to buy them or lucked into them in the first place. These are things like houses, cars, a farmer’s livestock or harvester machine, a company’s ship, your health, the retirement savings you would have left for your family over thirty years. If one of these is suddenly lost or destroyed (or you die in the last case), there’s a huge hole you have to fill but you can’t. So you take out a bet against yourself. You bet each year that you’ll incur this loss. If you lose, the event didn’t happen and you lose your wager. It’s unlikely and the wager was small so no big deal. If you win though, something terrible happened but you win enough money to be made whole…mostly. That bet is insurance. By taking it, you’re caping your potential loss at an amount you can afford to live with. That amount is your deductible. The bet gets cheaper the higher that deductible is. Insuring damage to a home above $5k is cheaper than damage above $1k. Fewer things will do $5k in damage and the payout will be less. But if $5k is more cash than you just have floating around for incidentals, you might want more insurance. Of course the max payout also affects the price.
There is a caveat on deductibles – If the loss happens because of another person or company’s actions, you and your insurance company may be able to make them and their insurance company pay for it. If they do, you get your deductible back since someone else made you whole. It if’s your fault or the fault of something like a storm, this doesn’t happen.
Interesting side note – Many wealthy people and companies balk at insuring things that all things considered are not that expensive for them or where they do so much activity that annual losses are inevitable and any insurer would functionally have to charge them for them anyway. So a major consulting company may not want to pay premiums for health insurance or business car insurance because it is very rich and with a 100k strong workforce, people are getting sick and getting into car accidents on any given day more or less. In these cases, insurers will often sell administration only packages where the company pays the actual claim and they just do the paperwork, adjusting, and compliance. They can also sell surety or bond products where the insured is responsible for paying the claim, but if they don’t the insurer will pay it and then take on the task of recovering the money from their client by force if necessary.
Lots of comments about how a deductible changes your premiums or keeps you from submitting small amounts.
It’s worth expanding a bit that insurance works best to cover rare but impactful events. Frequent events can’t be pooled well with other policies. At no profit you would just be paying the same amount to your insurance company as you do to self insure these common risks. Pooling is the basis of insurance… Spreading a risk across a large number of policies knowing you will pay some big claims but avoid paying for the minor scratches and dents every car gets.
Some insurers will have coverage options to wave deductibles on large enough claims as the events are rare enough that you can spread the cost of that deductible around and barely raise premiums.
Insurance is a transfer of risk. Deductible is your share of the risk. You accept more risk (higher deductible) you pay less premium. If you accept less risk (lower deductible) you pay more premium.
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It’s a way to reduce premiums, which reduces upfront costs for customers and instead makes it s hidden cost to screw you over when you actually need insurance. It’s the same thing as airlines showing you cheap tickets upfront and then adding every fee and tax under the sun before checkout.
Deductibles are the actual cost of services rendered, well most of it. See we play this cat and mouse game because insurance doesn’t like to pay out so the costs billed to insurance is inflated knowing it comes down, but often enough for a lot of services the deductible nearly as much as the cash price (outside of catastrophic accidents). It’s a trick to make sure everyone is paying. And occasionally afford to pay out catastrophic accidents.
A deductible is a way to keep rates lower by defraying a claim cost for insurance and by setting a bar at which a claim is even considered.
Imaging you have zero deductible. You could file a claim every time you get a door ding at the grocery store and have insurance pay to fix it. And if customers did this and the insurance company paid out for a ton of little claims, it’d mean having to charge higher rates. But by setting a point where one will not submit a claim at all, it allows rates to remain cheaper.
Also, it makes you more careful as a driver because even if you don’t have to pay the full $5000 repair if you’re at fault in an accident, it still hurts enough to pay $500 or $1000 that you don’t drive recklessly.
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