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What are Deductibles?

An insurance deductible is a specific amount that must be paid before your insurance policy kicks in and pays for some or all of your claims. In other words, by signing up for an insurance plan, you agree to pay a certain amount upon filing a claim, called a deductible, before the provider pays. Once the deductible is paid, the insurance company will pay off the rest of the claim in accordance with its policy limits.

Deductibles are often listed as dollar amounts, but they may be stated as a percentage of the costs the insurance company will pay. Although deductible prices vary depending on the policy, a higher deductible usually means a lower premium since you will be liable for more costs before coverage begins.

Key Takeaways

  • A deductible is a specific amount that must be paid before your insurance policy pays for some or all of your claims.
  • Following the payment of the deductible, the insurance company will pay off the rest of the claim.
  • Deductibles are used by insurance companies to ensure that policyholders share the risk of their claims.

How Does a Deductible Work?

Generally, a deductible is the amount of money you will pay out of pocket toward a covered claim. However, depending on the type of insurance policy you have, the deductibles will work differently. For instance, let’s take a look at auto insurance. Imagine you accidentally backed your car into a tree while parking, causing your car to rack up $2,000 in damages. If you already paid a deductible of $500, the insurance company would pay $1,500.

On the other hand, health insurance deductibles are not as simple. When it comes to health insurance, a deductible is a fixed amount that must be reached before your insurance policy begins to cover costs. Your annual deductible, for example, might be $2,000, which means you will be responsible for the first $2,000 of your healthcare costs. Then, when you go to the doctor, you simply pay your coinsurance or copayment only.

Why Do Insurers Require Deductibles?

Deductibles are included in insurance policies for two main reasons:

Moral Hazard: Moral hazard comes from the possibility that a policyholder may not act in good faith. Policyholders are protected from losses, so there is a clear moral hazard regarding insurance policies. The insured party may choose to engage in risky behavior without experiencing any financial consequences. For instance, a driver may disregard safety and drive recklessly if he or she has car insurance since the cost of an accident will be covered by the policy. Without a deductible, they don't have any "skin in the game," and therefore may not have the proper motivation to mitigate risk.

Financial Stability and Reduction of Claims: For the insurer, deductibles are the key to maintaining financial stability and reducing claims. The deductible allows for the risk to be split between the insurer and the policyholder, which in turn protects the insurer from catastrophic loss. Without deductibles, every claim would be the insurer's responsibility, regardless of its amount. Insurance companies would be overwhelmed with claims, causing premiums to rise and making it difficult for them to focus on more serious claims.

Bottom Line

Deductibles are important parts of insurance policies that allow you to save on premiums while protecting yourself from losses. Learn more about how deductibles work and how out-of-pocket costs will affect you by reaching out to a professional insurance lawyer.

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