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The deductible is one of the most important parts of any insurance contract. Your deductible not only affects the amount which will be subtracted from future claims, but it also has a very significant impact on the cost of the policy. As such, the deductible is rightly one of the first elements that most people consider when shopping for homeowner or renters insurance coverage.
If you’re asking yourself how do insurance deductibles work you’re not alone. Especially for first-time insurance buyers, this question is a common one.
A deductible is an amount of money that you, as the insurance holder, are responsible for putting toward a claimed loss. Let’s say you were renting a house and it was damaged in a fire. You are insured up to $20,000 of personal property losses, but you only need to claim $10,000. The deductible on your renter’s insurance policy is $500. As such, you are responsible for paying that $500 out of pocket for replacements or repairs before your insurance policy kicks in to cover you for the additional $9,500. The deductible amount—the $500—is “deducted,” or subtracted, from the full claim amount.
The above model, where the deductible is a specific dollar amount, is the most common form of the insurance deductible. However, there are also situations where the deductible may manifest itself as a percentage of the total insurance policy value. This model is mostly only common in homeowners insurance policies. So, if your home is insured for $300,000 and you have a three percent deductible, then you would need to pay $9,000 out of pocket on any claim. In other words, if your house caught fire and you ended up making a $75,000 claim on your insurance policy, your claim check would be $66,000 rather than the full $75,000.
Insurance companies put deductibles into their policies as a way of sharing the risk of an incident with you, the insured. Sometimes, consumers bristle at this suggestion. They believe their monthly premiums already represent a “sharing of risk” with the insurance company. Why should the customer be expected to participate in paying out of pocket toward the claim if he or she is already paying a monthly premium? Especially among first-time insurance buyers, this question is a popular one.
The simple answer is that every insurance buyer gets to decide whether they’d rather shoulder more risk: with the monthly payment or with the deductible? If you take on more risk with the monthly payment, that means you are paying a higher insurance premium rate. In exchange, you get a lower deductible. You are investing more on a month-to-month basis to make sure that you won’t have to pay a big out-of-pocket lump sum if something happens and you must make an insurance claim. Alternatively, you can opt for a lower premium rate, with the knowledge that you will have to pay a higher deductible if you claim on the policy.
There is no hard and fast rule about the “right” way to set up your insurance deductible. Ultimately, the decision will vary from one person to the next. Factors that may affect your decision include how much money you have saved, your likelihood of making a claim, and your aversion to risk. The decision should depend on factors both in your control and out of your control. For example, if you live in an area prone to hurricanes, you should consider yourself in a higher-risk environment. If there are a lot of car burglaries in your neighborhood and you tend to forget your laptop in your car – renters insurance actually covers that! – that too should go into your decision.
There are numerous situations where it might make sense to increase your deductible and enjoy those monthly and yearly savings on premiums. If you live in a new building with an alarm system, good plumbing, and feel confident about how you handle your belongings, then shouldering a higher deductible might be preferable to paying high monthly premiums on coverage.
On the other hand, if you live in a disaster-prone area where hurricanes and summer fires are a reality, then choosing to pay a bit more every month is a reasonable choice. Of course, you should always assess your financial situation before taking on a higher deductible. If you have the savings to handle a high deductible, then the decision is up to you. If a $2,000 or $3,000 deductible would bankrupt you, you shouldn’t take that risk.
Ultimately, the decision is up to you. Some people raise their deductibles only to regret the decision later. Thinking about paying $2,500 out of pocket is easy when risk is an abstract possibility. It’s a lot harder when something actually happens, and you must write a check for that amount. Shooting for lower deductibles on renters insurance when you don’t live in a secure, stable environment is risky since you never know when you will need that coverage. When in doubt, chat with your insurance broker. That way, you can get a better sense of how much you will save—both monthly and annually—by upping your deductible and lowering your premiums. Putting a concrete number on the savings should help you decide what to do next.