Why Large Deductibles on Insurance Policies Are a Good Thing

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KEY POINTS

  • Anyone buying insurance must decide how large their deductible should be.
  • Consumers have a choice between low premiums and high deductibles, or high premiums and low deductibles.
  • For many people, a high deductible policy is a better option.


Consumers should think carefully about whether a high deductible policy is the best choice.

As a consumer buying insurance coverage, the size of your deductible is an important issue. A deductible is a sum of money that a policyholder must pay personally prior to insurers paying the remainder of a covered claim. For example, a driver with collision insurance who has a $2,000 deductible would need to cover the first $2,000 in repairs before the insurer would pay out the remainder of the money to repair or replace the vehicle.

Insurers offer policyholders a choice when it comes to their deductibles. Coverage is available with a high deductible, which typically has low premiums. Insured policyholders take on more risk of future costs with this kind of policy. Alternatively, policies with low deductibles are also an option but premiums are usually higher.

Each consumer should carefully consider which option is best for their needs. In many cases, however, a policy with a large deductible is a good choice. Here's why.

The simple reason why large deductibles can make sense for many consumers

Large deductibles can make good sense for many consumers because of the premium savings they provide. While a high deductible policy means a consumer might have to pay more if something goes wrong, the policyholder gets the benefit of guaranteed lower premiums for the entire time they have the coverage in place. And for consumers who can be strategic about how they manage this savings, they can end up effectively getting the same protection a lower deductible policy would provide -- without the added costs.

To understand how this can happen, say for example a homeowner's insurance policy with a $1,000 deductible saves 25% over a policy with a $500 deductible. That could mean a homeowner has a choice of paying $1,500 per year for a policy with a $500 deductible or $1,125 per year for a policy with a $1,000 deductible.

That homeowner would save $375 per year or $31.25 per month by opting for the policy with the higher deductible. Over the course of 16 months, the policyholder who chose the plan with the $1,000 deductible would be able to save the added $500 they'd have to pay if something went wrong with the property.

Setting the money aside and not making too many claims is crucial

If they put that $500 into a special account to cover the added costs they'd be responsible for, then they'd only need to come up with another $500 if they had to make a claim -- the same amount as they'd owe with the lower deductible plan.

From then on, the extra $31.25 per month could be diverted to other things, leaving them better off than if they had the costlier insurance coverage. So as long as they didn't have to make a claim on their home insurance more often than every 16 months, they'd be in good shape.

Of course, policyholders need to make sure they have the money saved up to cover out-of-pocket costs if they opt for a high deductible plan. But it often makes sense to do so, as it can lead to less spending over time.

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