Everything about insurance is a trade-off. Your insurance provider takes on your risk, you take on their bill. You pay money now; they’ll pay money later. Even the pay structure of insurance involves a trade-off: You can pay a high premium, then pay a lower deductible in case of a claim… or you can pay a reduced premium, and shoulder a bigger deductible before any insurance payout will kick in. But how do you know which option is right for you?
What is a deductible?
The amount you, the policyholder, “pay” toward a claim. This amount is “deducted” from the check your insurance company writes you. If you have an insurance loss of $8,000 and carry a $1,000 deductible, you’ll get $7,000.
If you have a high risk-tolerance — and a plump emergency fund — a bigger deductible allows you to save some cash on your monthly or annual premium. This isn’t the riskiest bet you could place, since most homeowners only make a claim on their homeowners insurance once every 10 years. If you feel confident banking on that probability, you may come out about $100 ahead every year.
But if you stand firmly in the “better safe than sorry” camp, a lower deductible buys you some assurance (at the cost of a higher premium). If a storm, a fire, or an act of vandalism leaves you with expensive repairs and replacements, you won’t be unexpectedly saddled with a multi-thousand dollar deductible. If you don’t have a nest egg big enough to take care of that expense, a low deductible will keep your financial life more predictable.
Types of Deductibles
There are two formats of deductibles, but one is far more common in homeowners insurance. A dollar amount deductible is the standard, available at three levels: $500, $1,000, or $1,500. Most people opt for the mid-range option, paying a $1,000 on any claim.
The other, less common option is a percentage deductible, which is some percentage of your home’s total insured value. A 1% deductible on a home insured for $250,000 would be $2,500.
No deductible on liability claims
Typically, deductibles are only subtracted from your claims payout if the claim falls under the “Property damage” category of homeowners insurance. For liability claims and medical payments — a tree on your property falls on your neighbor’s garage; a guest trips down your stairs — there’s no deductible.
Why You Might Want a Lower Deductible
In the event of a claim, having a high deductible might be more painful than you think. Deductibles, remember, are the amount subtracted from the check the insurance company writes. Consider how the loss of $2,000 from that check would feel after a major loss. If it’s not a difference in assistance that you could easily absorb, it may be worth it to you to pay a little more over time.
But even if you can’t stomach a high deductible, it doesn’t necessarily follow that you should choose the lowest deductible. A middle-of-the-road deductible can beneficially serve as a deterrent to making unnecessary claims. Plus, it keeps a little extra cash in your wallet during years without a claim.
The long-term cost of a low deductible
Low deductibles might make you more tempted to file a claim. Here’s why that could be a bad thing: Insurance companies — all of them, not just the provider you’re currently with — know your claims frequency. Companies use it to assess your risk. Every claim is entered in the database CLUE (Comprehensive Loss Underwriting Exchange). It acts much like your credit report. Too many claims (think two in 10 years) looks risky. You could face increasing premiums from your current company, even a canceled policy. And you could be forced to get a low-quality or high-cost homeowners insurance elsewhere.
To avoid these troubles, ask yourself if a potential claim is really necessary. If a given claim doesn’t merit a substantially higher payout than the cost of your deductible plus the cost of a higher premium, you shouldn’t file that claim. A higher deductible raises that threshold, forcing you to weigh the cost of filing.
Why You Might Want a High Deductible
If you’re pretty good with money — you have a growing retirement account, a diversified portfolio, a solid chunk in savings — you may be able to absorb a big deductible. In that case, you could store away the annual savings from taking a high deductible and “self-insure.”
Earmark a portion of your savings account (or set up a separate, dedicated account) as home emergency funds. Unlike paying your premium, this is money that is freely available to you even if you don’t end up making a claim.