UPDATED: Mar 19, 2020
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If you have been considering using a very high deductible on your policy, you may want to reconsider. Even though a higher deductible will result in a lower premium, there are long-term consequences to think about. Unfortunately, for many policyholders, the deductible is just one of many numbers on their policy that they don’t understand. Before you purchase a new coverage or make any changes to your existing policy, do your research and make sure that you’re making the best decision for your personal financial situation.
What is the Purpose of a Deductible?
Selecting a higher deductible can save money, but you should have a thorough understanding of how this policy feature works. To put it simply, a deductible is the amount you agree to pay out of pocket if a claim is filed. It’s important to remember to subtract this amount from a property damage assessment when determining how much your insurance company will pay out on a claim. For small claims, it’s often necessary to find out what the amount of damage is before filing a claim since any amount less than the deductible won’t be covered. Some people choose to pay for damage out of pocket instead of filing a claim if they know the damage is only slightly more than their deductible.
Consider this example: you accidentally back your car into a light pole and damage your bumper. You know your auto insurance policy will cover the damage because you have collision coverage, but the extent of the damage is minor and you suspect it may be less than your deductible of $1,000. Instead of filing a claim and possibly having the insurance company deny it, you may choose to take your car to a body shop for a free damage estimate. If the body shop says the damage is less than $1,000 to repair, you shouldn’t file a claim because your insurance company won’t pay anything. However, if the damage is just $1,200, your insurer would only be paying $200 towards the repairs. Many people feel that it’s better to pay the entire amount out of pocket when the insurance company will pay such a small amount.
Some types of coverage are not subject to a deductible. Liability, for example, is always paid out at one hundred percent by the insurance company. Uninsured motorist coverage, which covers your vehicle for damage caused by an under or uninsured driver, is another coverage that is typically not subject to a deductible although some exceptions may occur.
Contrary to popular belief, a deductible is not paid to the insurance company. For auto claims, the deductible will be paid to the auto body shop that repairs your vehicle. With property claims, the deductible is paid out to the contractor or restoration company that repairs your property. With personal property claims, such as theft, the deductible amount is simply subtracted from the check your insurance company issues to help pay for the items to be replaced.
Reasons to Choose a Higher Deductible
The most common reason people opt for higher deductibles is to save money. Unfortunately, not everyone considers how a higher deductible could affect their finances later. Although an increased deductible will free up a small amount of money on your monthly premium, it could cause problems later if you have to struggle to get the cash for your deductible.
Occasionally, individuals will with ample savings will use a larger deductible because they know if they need to file a claim, they have enough in their savings to cover their out-of-pocket expenses. Since having a higher deductible lowers your premium, these policyholders will save more money in the long run. Some people choose to take the difference in premium and add it back to their savings. For example, imagine you select a deductible of $1,000 rather than $500 and it saves you $25 a month on your premium. If you take the money you saved and put it into a savings account, it would take 20 months, or almost 2 years, to save enough to pay for the cost difference.
Rarely, insurance companies may raise the deductible on your policy without giving you the option to keep the deductible you had previously. This has become more commonplace in the last few years due to insurers looking for new ways to offset necessary premium increases. While some companies will just raise the minimum deductible option on new policies and allow existing policies to keep their current deductible, this isn’t always the case. If your insurance company raises your deductible, you may want to begin a savings account to ensure you have cash on hand for a potential claim.
How to Select the Best Deductible
Before you select a deductible on your policy, discuss the decision with your agent. Find out what deductibles are available and how your premium will be affected. Insurance companies each have their own formula for calculating insurance rates and, unfortunately, a higher deductible doesn’t always result in a huge premium reduction. Especially with comprehensive coverage, you may find that a higher deductible doesn’t result in enough of a premium reduction to justify making a change.
Once you have discussed your options, consider what deductible you can afford. While many people can manage to scrape together $500 in a pinch, coming up with $1,000 or $2,500 is much more difficult. A good way to calculate what deductible you can afford is to imagine you file a claim tomorrow. Given your current financial situation, what would it take to come up with the deductible money? If you know that it would be difficult or impossible to come up with the money for the higher deductible, you should avoid raising your deductible at all cost, or at least until your financial situation improves.
Although insurance can be a confusing subject at times, you should never let it overwhelm you. Always contact your insurance agent and do some research before making any significant changes on your policy. Just because a friend recommends increasing your deductible to save money doesn’t mean that this is a good move for you. You should also take a look at additional ways to get cheaper insurance quotes. Consider every aspect before making a change so that you don’t wind up in a bad place later.