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Deductibles Decoded: What Works Best for You?

Unexpected financial losses can strike at any time of the year, but it could be particularly devastating during the holiday season. Homeowners and automobile insurance may help you handle the stress of certain covered losses. However, you should understand and be comfortable with the financial risk a deductible represents.

A deductible is the amount a policyholder must pay out of pocket before the insurance company pays the covered amount on a claim, up to the policy limits. Having a deductible in place means that the insurer and the insured agree to share the risk according to a predetermined formula. Thus, it’s important to balance the amount of risk and the cost of your premiums.

How Much Could I Save?

Choosing a higher deductible for a specific type of coverage typically reduces the premium for that coverage. Most policyholders do not file claims very often, so choosing larger deductibles for your homeowners or auto policies may offer you a way to save money over time and still be protected financially from a major loss that you could not afford to pay for on your own.

For example, one study found that increasing a homeowners insurance deductible from $500 to $2,000 lowered the average annual premium by 16% nationally.1 Similarly, raising the collision deductible on an auto policy from $200 to $500 could reduce the premium by as much as 30% annually. The average driver files a collision claim only about once every three years, so settling for a higher deductible may save you money in the long run.2

Keep in mind that if you carry a high deductible for a homeowners or auto policy, you might need a larger emergency fund to prepare for potential out-of-pocket expenses.

Defining Percentage Deductibles

Standard homeowners policies typically have a flat deductible expressed as a dollar amount. These policies offer protection from fire, lightning, theft, wind, and other stated “perils,” but natural disasters such as earthquakes and floods are usually excluded.

If you live in an area with a risk of a natural disaster that is not covered by your homeowners policy, you may need a policy endorsement or a separate disaster insurance policy. For this type of coverage, a larger deductible based on a percentage of home value might apply. (Some standard policies also may have this feature.) For example, hurricane deductibles usually range from 1% to 5% or more of the insured value, with 2% being the most common.3

Earthquake policies typically have deductibles ranging from 2% to 20% of the home’s replacement value, depending on the region’s perceived level of risk and other factors. The standard California Earthquake Authority policy comes with a 15% deductible. Insurers in other states with a higher-than-average risk of earthquakes (such as Washington, Nevada, and Utah) often set minimum deductibles at around 10%, but policies with higher deductibles may be offered at a lower cost.4

When purchasing or reviewing a policy, it’s important to ask about deductibles and compare the rates for each of the available options. Your insurance agent can answer any questions you may have and make coverage recommendations based on your potential risks and financial situation.

1, 3) The New York Times, May 29, 2015
2) CNNMoney, May 28, 2015
4) Insurance Information Institute, 2015

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2015 Emerald Connect, LLC.

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