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 insurance deductibles.
We’ll be looking at:
What is 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 although 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:
1. You chose a deductible of $250 when you bought your policy
2. Later on, you file a claim for a stolen watch valued at $1,000
3.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.
1. You chose a deductible of $250 when you bought your policy
2. Your $200 headphones get stolen
3. 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 🙂
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:
1. Do I have at least 3 months worth of paychecks in my bank account?
2. What amount can I cover myself before I need help from my insurance company?
3. 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.
4. Do I generally keep my breakable/valuable items safe? Be honest, really!
5. 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 homeowners insurance. 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:
1. Head on over to eBay or Amazon and take a look at how much items similar to yours are sold for
2. Search for the make and model of your item on a search engine, and take a look at cost of the first few results
3. Go to an online valuation site to gauge the cost
4. Look for an online forum that talks about the item you’d like to price and ask the community for an estimate
5. If you happen to have antiques, consult with an antiques dealer to get an official appraisal
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 invest 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.
At Lemonade, things work a bit differently
Many people experience anxiety before filing a claim, and in many cases just give up altogether. And who can blame them?
Often, the stuff we’d like to claim is below the deductible we originally chose, which means that filing a claim wouldn’t make any sense. For example, if we chose a deductible for $500, and our $450 headphones, we’re so out of luck. In other cases, people may be tempted to embellish claims to get them above their deductible amount, and that’s not too great either.
Filing claims should be a pleasant and reassuring experience. After all, claims are the reason why we all get insurance in the first place.
Where to find and how to change your deductible
If you happen to forget what deductible you chose, you can always check out the declarations page on your insurance policy.
If you have Lemonade, you can simply open your app and check. Additionally (for Lemonaders), if you’d like to change your deductible at any point, click “Edit Coverage” on the home screen of the app, scroll down to the deductible section, and change away! It’ll only take a few secs, and you’ll get confirmation of your updated policy via email right away 🙂
Deductibles for specific events
Insurance companies also offer unique deductibles for specific things like hurricanes or fires, which are a percentage of a specific limit. So, make sure to double check for these add-ons (called endorsements, in insurance) when you’re purchasing a policy.
Lemonade values insurance that makes sense for people: instant, easy, and honest. From this came Zero Everything. With this feature, Lemonade customers will no longer need to pay deductibles or have their rate increased when filing claims.
That’s right: Zero deductible. Zero rate hikes. Zero worries.
Regardless of the value of your claim, you’ll receive the full amount needed to replace your items with new ones!
1. A deductible is an amount of money you choose when purchasing a policy that will be subtracted from any future claims payouts.
2. You choose your deductible amount, which typically ranges from $250 – $2,500
3. In general, a lower deductible means a higher monthly premium, and vice versa
4. It’s best to choose a deductible amount that’ll make sense for you, considering your financial health
5. Deductibles exist to make you be a bit more careful with your stuff and to keep the cost of policies low for everyone