DEDUCTIBLES FROM CLAIMS

A policy may stipulate that losses are to be reimbursed only in excess of a stated threshold amount, called a deductible. For example, consider insurance that covers a loss resulting from an accident but includes a 500 deductible. If the loss is less than 500 the insurer will not pay anything to the policyholder. On the other hand, if the loss is more than 500, the insurer will pay for the loss in excess of the deductible. In other words, if the loss is 2000, the insurer will pay 1500.

Reasons for deductibles include the following:
(1) Small losses do not create a claim payment, thus saving the expenses of processing the claim.
(2) Claim payments are reduced by the amount of the deductible, which is translated into premium savings.
(3) The deductible puts the policyholder at risk and, therefore, provides an economic incentive for the policyholder to prevent losses that would lead to claim payments.

Problems associated with deductibles include the following:

(1) The policyholder may be disappointed that losses are not paid in full. Certainly, deductibles increase the risk for which the policyholder remains responsible.
 (2) Deductibles can lead to misunderstandings and bad public relations for the insurance company. (3) Deductibles may make the marketing of the coverage more difficult for the insurance company. (4) The policyholder may overstate the loss to recover the deductible.

Note that if there is a deductible, there is a difference between the value of a loss and the associated claim payment. In fact, for a very small loss there will be no claim payment. Thus, it is essential to differentiate between losses and claim payments as to both frequency and severity.