Simply stated: A deductible is the amount that you pay toward a loss or claim before the insurance company begins to pay.
The higher your deductible, the lower your premium.
- The more you are willing to participate in your loss, the greater the savings on your premium.
The insurance company will offer your a lower premium if you take a higher deductible because your LOSS FREQUENCY and your LOSS SEVERITY will be lower. Consider if you have a $2000 deductible instead of a $500 deductible:
- You’ll make fewer claims because you won’t be making claims for $600, $900 or $1995 losses. You’ll simply pay those yourself. (FREQUENCY)
- When you do submit a claim the insurance company will be paying $1500 LESS than if you had the $500 deductible. (SEVERITY)
There is no “correct” deductible to choose. It depends on what I like to call your personal LOSS THRESHOLD. So before get too far ahead, lets take a moment to diagnose your “loss threshold.”
Lets say you go out and buy a $3 picture to hang in your bathroom. Are you going to insure it? Of course not! Now you go out and buy a famous $252,000 masterpiece painting. Are you going to insure it? Unless you are a multi-millionaire, you certainly will. Somewhere in between the $3 print and the $252,000 masterpiece is your loss threshold. Your loss threshold is the amount of money you can stand to lose without doing any great harm to your daily lifestyle or your peace-of-mind. In the above example, different people will have different thresholds. There is no right or wrong answer here!
ANOTHER SIMPLE CALCULATION….
OK. Let’s say you’re ok with a loss threshold of $1000 or less. Now you can choose between a $1000 deductible or a $500 deductible. Find the premium difference between the two. Let’s say you save $80 a year in premium to take the $1000 deductible.
Now look at the DIFFERENCE between the 2 deductibles which is $500. It would take you over 6 years ($80/yr x 6 years = $480 ) to save the DIFFERENCE between the deductibles.
Now you simply ask yourself, “Do I think I’ll have more than 1 claim in the next 6 years?” If the answer is yes, you should probably take the lower ($500) deductible. If the answer is no, then the higher deductible ($1000) probably makes more sense.
If you’re still confused by this, just give me a call and I’ll walk you through it….