Definition
In finance, a deductible refers to the amount an insured individual must pay out of pocket before the insurance company begins to cover costs. It serves as a form of self-insurance for the policy holder. Deductibles can be applied per incident, or they may be set as an annual total amount.
Key Takeaways
- The term ‘Deductible’ refers to the amount an insured individual needs to pay out-of-pocket before their insurance coverage starts. It’s a part of an insurance policy that the policyholder agrees to pay when they file a claim.
- Deductibles are commonly used in many types of insurance such as auto, health and homeowners insurance. The amount can range from a few hundred to several thousand dollars, depending on the type of insurance and your policy terms.
- The higher your deductible, the lower your insurance premium tends to be. This is because you’re agreeing to handle a larger portion of your own costs, which means you pose less financial risk to your insurance company.
Importance
The finance term “deductible” is important because it refers to the amount a policyholder is responsible for paying out-of-pocket before their insurance coverage kicks in.
It is a significant component in insurance policies, specifically in health, auto, and homeowners insurance.
The deductible amount is commonly set when the policy is established and has a direct impact on the premium—the higher the deductible, the lower the premium, and vice versa.
Understanding your deductible is crucial in financial planning as it helps assess the potential financial risk you’re willing to assume in the event of an accident, illness, or damage to property.
Explanation
The purpose of a deductible in a finance context, particularly in insurance, plays a pivotal role in sharing the risk between an insurer and a policyholder. A deductible is essentially the amount of money a policyholder must pay upfront towards a loss before the insurance company begins to pay out on a claim.
By employing a deductible, the insurer limits its own potential cost while also discouraging trivial claims. Therefore, it serves as a means of minimizing the risk of excessive claims, thereby helping to keep insurance premiums lower overall.
Deductibles are designed to balance the financial responsibilities and preserve the fairness between insurance companies and policyholders. Policyholders agree to be responsible for first-tire losses up to a specific threshold established in the policy (the deductible), which reduces the probability of insignificant claims.
Insurers, then, cover the losses exceeding this threshold up to a maximum limit. High deductibles have a significant role as well as they lower premiums by reducing the number of small claims and discourage policyholders from making small, unnecessary claims, thus protecting the overall financial health of the insurer.
Examples of Deductible
Health Insurance: This is probably the most common scenario where deductibles are involved. Suppose you have a health insurance plan with a deductible of $
This means you will have to pay the first $1000 of the covered healthcare services yourself before the insurance company starts paying. For example, if you have surgery that costs $5000, you will pay $1000, and then your insurance company will cover the remaining $
Auto Insurance: Deductibles are also commonly involved in auto insurance policies. If you have an auto insurance policy with a $500 deductible and you get into an accident that causes $2000 worth of damage to your vehicle, you would pay the first $500 worth of repair costs and the insurance company would pay the remaining $
Home Insurance: Just like in the two previous examples, home insurance policies typically involve a deductible. If your home suffers $10,000 worth of damage from a fire and your insurance policy has a $1,000 deductible, you would be responsible for paying the first $1,000 worth of repair costs from your own pocket, and your insurance company would cover the remaining $9,
FAQs on Deductible
What is a deductible?
A deductible is the amount you pay out of pocket for expenses before your insurance company covers the remaining costs. It is a specific amount set by your insurance policy.
How does a deductible work?
When you have an expense that is covered by your insurance policy, you’re required to pay the amount of your deductible before your insurance company pays any of the remaining balance. For instance, if you have a $1000 expense and your deductible is $200, you’ll pay the first $200 and your insurance would cover the remaining $800.
What’s the difference between a deductible and a premium?
A deductible is the amount you pay for services your insurance covers before the insurance company pays. A premium, on the other hand, is the amount you pay to have the insurance policy itself, typically on a monthly basis.
Does a higher deductible mean lower premiums?
Yes, typically a higher deductible means that your monthly insurance premiums will be lower. This is because you’re agreeing to pay more upfront for services before your insurance kicks in.
What types of insurance policies have deductibles?
Many types of insurance policies have deductibles, including health, auto, and homeowners insurance. The deductible amounts vary widely depending on the type of insurance and your specific policy.
Related Entrepreneurship Terms
- Premium
- Claim
- Coverage Limit
- Out-of-pocket Maximum
- Co-payment
Sources for More Information
- Investopedia: This site provides definitions of thousands of financial terms, including deductible. They offer articles, tutorials, and other educational resources on a wide variety of financial topics.
- The Balance: This financial advice site offers detailed articles that clarify the concept of deductibles, as well as other financial and insurance terms.
- NerdWallet: NerdWallet covers all aspects of personal finance including insurance deductibles. They provide expert insights, calculators and comparison tools.
- Bankrate: Bankrate is a comprehensive resource for personal finance information and advice, with articles that clearly explain the concept of a deductible.
