Insurance policies today come with deductibles. What does that mean? Briefly, a deductible is the amount of a loss payment the insured is responsible for. It is deducted from a loss payment. So, for example, if the covered loss to an insured’s home is $12,500, and the insured has a $500 deductible, the insured will receive $12,000.
The theory behind this practice was to prevent small losses from being turned in to the insurer. For example, a kid’s baseball sails through a windowpane, breaking it. The cost to repair the damage is $65.00. Now, technically, this loss is covered. But should the insurer pay for the loss? Your answer would, at first, be “Yes, of course!” But wait, what if the cost of paying such minor claims drives up your premium from, say, $1100 per year to $1,500 per year? Would you find it more cost effective to pay the $65.00 or the $400? Okay, that’s somewhat simplistic, but that is the reasoning behind deductibles.
Deductibles can take two forms, either dollar amount or a percentage. A dollar amount deductible means the chosen amount applies to a loss, while a percentage amount usually applies to the insured property’s value in determining the dollar amount. For example, if a home is insured for $400,000, and a 1 percent deductible is selected, then a $4,000 dollar amount applies to a loss. If the home’s value increases to $450,000, then the deductible becomes $4500.
Many years ago some insurance policies utilized a “disappearing” or a “vanishing” deductible. This meant that, once a loss reached a certain dollar amount, the deductible would begin to be absorbed into the loss; if the loss was great enough, the deductible disappeared entirely. These deductibles are less common now, if available at all. We should mention that some car insurers are advertising a “disappearing deductible” as a reward for safe driving, but we are concerned with property coverage.
So, beyond a straight dollar deductible for regular property losses, what other types of deductibles are there? There is a hurricane deductible, which applies only to hurricane losses. The trigger for these might either be the first appearance of a named storm, or the entire season, as set by the state and insurers. Obviously in California there is little need to worry. A wind and hail deductible, as the name implies, applies to losses caused by wind and/or hail. In the Midwest, thunderstorms with wind, lightning, and hail are frequent. And, or course, there is “tornado alley” running through Nebraska and Oklahoma. Wind and hail deductibles are usually a percentage deductible, as are hurricane deductibles.
Flood deductibles vary by insurer and by state, but are usually a percentage. However, different deductibles can be chosen for dwelling and contents. Then we come to earthquake deductibles. These are typically a percentage of the replacement cost of the home. The California Earthquake Authority imposes a 15 percent deductible on the replacement cost of the home, and 10 percent on any additional coverages, such as for other structures.
Now we come to coinsurance. This part of an insurance policy is one of the least understood. Essentially, it is another way for an insured, under certain conditions, to assume a part of a covered loss. But wait, isn’t that what a deductible does? Well, yes, but a deductible will always apply to a loss, while the coinsurance clause is often referred to as a coinsurance penalty.
Basically, coinsurance is a way for insurers to encourage consumers to insure their property for its value, whether replacement or actual cash value. We will use homeowners insurance as an example. You will find this clause in the loss settlement provision of your policy. Let’s say that your home’s replacement value is $600,000. However, you see no reason to pay the premium on this amount, and so insure your home for $400,000, with a $1,000 deductible. You have a windstorm loss of $100,000. The coinsurance clause essentially states that you should have carried at least 80 percent of $600,000 (or 480,000) for the loss to be paid in full, but you did not. Therefore, this formula is used: did have divided by should have had times the amount of the loss less the deductible. In other words, $400,000 divided by $480,000 = .83 (rounded) times $100,000 = $83,333 less $1,000 = $73,333. That is the amount the insured will be reimbursed for this loss if the coinsurance penalty comes into play.
In short, you will generally be responsible for a deductible in event of a loss; however, you can control whether or not the coinsurance clause will come into play by making sure your property is insured to value.