Insurance can be confusing, so we’re here to explain insurance terms in an actionable and easy-to-understand way. After all, they’re important to some pretty significant financial decisions we’re likely to make in our lifetimes.
If you do a quick search for ‘insurance deductible definition,’ you’ll find heavy insurance jargon and some pretty vague definitions.
We’re here to dive deeper; to give you uncomplicated explanations and practical examples of renters and home insurance deductibles.
We’ll be exploring:
- What an insurance deductible is
- How insurance deductibles work
- How to choose an insurance deductible
- Why insurance companies have deductibles
Let’s get started!
What’s an insurance deductible?
An insurance deductible is an amount of money you choose when purchasing a policy that will be subtracted from any future claims payouts.
Let’s say your $750 iPhone was stolen and your deductible was $250. Your insurance company would pay you $500.
Think of a deductible as your participation in the damage or loss. You’re saying, “I commit X dollars to any claim on future losses or damages, and my insurance company will cover the rest.”
It probably sounds a little weird that you have to pay a monthly premium and, on top of that, you won’t get the full value of your stuff in return when things go sideways. But don’t worry, we’ll dig into why that is a bit later. It’ll all make sense, we promise!
Usually, your deductible will be a fixed dollar amount, ranging from $250 to $5,000. Some companies also offer deductibles as a percentage of an insured value. Keep in mind that deductibles may vary based on where you live, as insurance regulations differ from state to state.
How do insurance deductibles work?
When signing up for a renters or home insurance policy, you’ll be asked to choose a deductible. This’ll typically range from $250 to $2,500.
What you’re choosing here is your participation (the amount subtracted from a claim) in the event that something happens to your stuff.
Here are a few examples:
- You chose a deductible of $250 when you bought your policy
- Later on, you file a claim for a stolen watch valued at $1,000
- If the claim is approved, your insurer will pay you $750 ($1,000 minus your $250 deductible)
If the total loss is less than the deductible, there’s no point in making a claim – your insurer can’t reimburse you for anything.
- You chose a deductible of $250 when you bought your policy
- Your $200 headphones get stolen
- Since the replacement cost of the headphones is less than your deductible, you won’t get anything from your insurer on this one
So, now you’re probably wondering… why doesn’t everyone just choose a low deductible to make sure that if anything goes missing, it’ll be covered in full?
Good question 🙂
In general, the lower a deductible you choose, the higher your monthly insurance rate will be. Conversely, if you choose a high deductible, your insurance rate will be lower.
How do you choose the right deductible amount?
First off, there’s no such thing as the “right” amount. Different people have different preferences – you’ll have to decide what’s right for yourself at the end of the day.
But we’ll try to help you decide.
First, ask yourself a few questions, such as:
- Do I have at least 3 months worth of paychecks in my bank account?
- What amount can I cover myself before I need help from my insurance company?
- Is most of my stuff easily replaceable? Pro Tip: If you aren’t sure how much your stuff is worth, try looking up similar products in Google.
- Do I generally keep my breakable/valuable items safe? Be honest, really!
- Would I prefer to pay a larger sum of money at one time in the event of damage or loss of an item, rather than a higher rate each month?
If you answered ‘yes’ to most of these questions, you’ll probably want to choose a higher deductible. If you answered ‘no,’ you’ll want to stick with something on the lower end of the spectrum.
Another helpful strategy is to think about something of value in your apartment or home. What would you be able to pay today if you had to replace it?
Let’s take a standard, 13-inch MacBook Air. It costs around $1,150, taking New York Sales Tax into account. We’ll assume you choose the minimum deductible – usually $250. That leaves $900.
What part of this amount would you be able to pay right now? All of it? Some? None? If you think you’ll need a little help, you should choose a lower deductible amount on your renters or home insurance policy. Essentially, the more “loss” you can afford, the higher the deductible you can afford and vice versa.
Not sure how to answer this because you don’t know how much your stuff is actually worth? No worries.
Here are a few helpful online and offline tips to figure that out:
- Head on over to eBay or Amazon and take a look at how much items similar to yours are sold for
- Search for the make and model of your item on a search engine, and take a look at cost of the first few results
- Go to an online valuation site to gauge the cost
- Look for an online forum that talks about the item you’d like to price and ask the community for an estimate
- If you happen to have antiques, consult with an antiques dealer to get an official appraisal
Bottom line: while a higher deductible may mean lower premiums, at the end of the day, you should choose an amount that fits your financial flexibility and lifestyle.
Why do insurance companies have deductibles?
The natural follow-up question to all of this deductible business is: if you’re already paying a monthly premium, why do you still have to participate in the claim? As promised, we’re here to get to the bottom of it.
There are two main reasons for the use of deductibles in insurance policies:
1. To mitigate the behavioral risks associated with moral hazard
That’s a mouthful, right?
Here it is again, in plain English: if you’re responsible for participating in some part of a future claim, you’ll more likely to be a bit more careful when it comes to your things.
2. To solve the classic “tragedy of the commons” problem
Yet another mouthful.
Consider this: how many claims would insurers have to handle if they responded to every single claim, no matter how small? Think: scratched sunglasses, lost scarves, cracked phone screens, dented laptops, etc. That’s a lot of claims to manage.
The costs associated with these types of claims is enormous. Insurers would invest the same amount of time on a $5 claim as they would on a $5,000 claim. So if insurers took on every $5 claim that came their way, they’d be stretched too thin. Sometimes, the money it costs to deal with the claim is more than the claim itself.
Cue tragedy of the insurance Commons:
Insurance companies would have to hire more people or investing in more technology to handle the workload. This investment would have to be financed somehow, most likely at the expense of your insurance premiums. So, every person that files a new claim would directly impact other policyholders by increasing their premiums. Nobody wants that!
To sum it all up, insurance companies use deductibles to reduce loss exposure and to help keep premium costs at a minimum for all policyholders.
- A deductible is an amount of money you choose when purchasing a policy that will be subtracted from any future claims payouts.
- You choose your deductible amount, which typically ranges from $250 – $2,500
- In general, a lower deductible means a higher monthly premium, and vice versa
- It’s best to choose a deductible amount that’ll make sense for you, considering your financial health
- Deductibles exist to make you be a bit more careful with your stuff and to keep the cost of policies low for everyone
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