FOOL'S SCHOOL DAILY Q&A

Deductibles vs. Premiums

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By Selena Maranjian (TMF Selena)
April 1, 2003

Q. What's a "premium" and what's a "deductible"?

A. An insurance policy's premium is the amount you have to pay for the policy. For car insurance, as an example, your premium might be $800 per year (or more or less, depending on many things). The premium is what you pay to keep the policy in force.

The deductible is the amount or portion that you will have to pay on any claim. For example, let's say that you have a car insurance policy with a $250 deductible. If you have a small accident and the repair will cost $600, you'll have to pay the first $250 of that, and your insurance policy should cover the rest. If you have another mishap a few months later, you'll again have to pay the first $250 of the cost of the repair.

The lower the deductible you choose, the higher your premium will be. So, unless you are particularly accident prone, it's often smart to carry a fairly steep deductible to lessen the cost of the policy. Raising your home insurance deductible from $250 to $500 might save you 10% or more per year, while hiking it all the way to $1,000 could net you 20% to 25% in savings.

Remember that insurance is, theoretically, meant to cover catastrophic losses -- not every little accident. Also, if you make too many claims, an insurance company may raise your premiums or drop you altogether.

A good rule of thumb is to determine how much you could afford to pay out-of-pocket, without causing severe financial hardship, if you have a claim. Then make that amount (or the closest option offered by the policy) your deductible.

Before you agree to any insurance policy, ask about and make sure you understand what limitations there are to claims being paid, so you don't pay for insurance that won't serve your needs.

Learn more about insurance in our Insurance Center. You may not have thought about some kinds of insurance, such as disability or long-term care insurance, but they're vital for many people. Take a little time to learn more and you may be very happy you did, if some calamity occurs in the future. Additional insurance information can be found at InsBuyer.com and Yahoo!

If you have any questions, thoughts or opinions on this column, share them with others on our Ask the Fool discussion board.

This question and answer is adapted from The Motley Fool Money Guide: Answers to Your Questions About Saving, Spending and Investing. For answers to this and 499 other common money questions, check it out -- it's a handy resource.