2.4 Deductibles, Limits, and Loss Settlement

Deductibles — the Insured's Retention

A deductible is the portion of each loss the insured retains before coverage responds. Deductibles reduce premium, eliminate small nuisance claims that cost more to adjust than to pay, and reduce moral and morale hazard by keeping the insured financially involved in every loss. Raising a deductible is one of the simplest ways for an insured to lower premium without changing the limit or perils covered.

The two structures tested most are flat and percentage:

• Flat (straight) deductible — a fixed dollar amount subtracted from each loss (e.g., $1,000). Simple and the most common on standard dwelling and commercial forms.
• Percentage deductible — a percent of the dwelling/building limit, common for windstorm/hurricane and earthquake (e.g., 2% of a $300,000 limit = $6,000). Because it is tied to the limit, it grows with the value insured.

Three specialty structures round out the topic:

• Aggregate deductible — a single amount applied to total losses over the policy period; once met, later losses are paid in full.
• Franchise deductible — no payment until the loss exceeds a threshold, then the full loss is paid with nothing subtracted (common in inland/ocean marine).
• Waiting period — a time deductible used in business income coverage (e.g., 72 hours before lost income begins to accrue).

Limits of Insurance

The limit of insurance is the most the insurer will pay. Watch how limits stack:

• Per-occurrence limit — the maximum for any one event.
• Aggregate limit — the maximum for all covered losses in the policy period; once exhausted, the policy is spent.
• Sublimits / special limits — caps on specific property classes. Typical HO special limits: $200 money/coins, $1,500 jewelry/watches/furs by theft, $2,500 business property on premises, $1,500 watercraft.
• Blanket limit — a single limit covering multiple buildings or categories, which can avoid coinsurance shortfalls on any one item.

Limits and deductibles work together: the insurer pays the loss amount between the deductible and the limit. A loss below the deductible yields no payment; a loss above the limit is paid only up to the limit.

Loss Settlement Provisions

Settlement applies in this order: confirm coverage → value the loss (ACV/RCV from 2.2) → apply coinsurance (2.3) → subtract the deductible → cap at the limit. Following the order prevents the common mistake of subtracting the deductible too early.

Worked Settlement

Building RCV $400,000, insured for $400,000, 80% coinsurance satisfied, $50,000 partial fire loss, $2,500 deductible, RCV settlement:

• Coinsurance satisfied — no penalty.
• $50,000 − $2,500 deductible = $47,500 paid.

Other-Insurance and Apportionment

When two policies cover the same loss, an other-insurance clause decides how they share:

Pro Rata Example

Policy A limit $100,000, Policy B limit $300,000, $40,000 loss. A pays ($100K ÷ $400K) × $40,000 = $10,000; B pays $30,000. These clauses prevent the insured from collecting more than the actual loss from multiple carriers, preserving indemnity.

Common Traps

• A percentage wind/quake deductible is based on the dwelling limit, not the loss — it can dwarf a flat deductible.
• A franchise deductible pays the entire loss once the threshold is exceeded; a straight deductible always subtracts.
• Special sublimits (cash, jewelry) cap recovery regardless of the overall limit.
• The deductible is the last subtraction — after coinsurance — not the first.

Worked Settlement with a Coinsurance Penalty

Combine the concepts in one fact pattern. A building has a replacement cost of $400,000 with an 80% coinsurance clause. The insured carries only $240,000 and has a $60,000 partial loss with a $1,000 deductible on an ACV basis.

• Should Carry = $400,000 × 80% = $320,000
• Ratio = $240,000 ÷ $320,000 = 75%
• After coinsurance = 75% × $60,000 = $45,000
• Less deductible = $45,000 − $1,000 = $44,000 paid

The insured absorbs $16,000 of the loss — $15,000 from the coinsurance penalty plus the $1,000 deductible. This four-step sequence (ratio, then deductible, then limit cap) is the single most-tested calculation in Chapter 2, so rehearse it until each step is reflexive.

Deductible Types and a Worked Calculation

Deductibles reduce small claims and lower premium. The exam tests several forms:

Worked example: a coastal home insured for $400,000 suffers $60,000 of hurricane damage with a 5% wind deductible. The deductible is 5% × $400,000 = $20,000, so the insurer pays $40,000. Trap: a percentage wind deductible is figured on the limit, not on the loss amount — a frequent miscalculation.

Limits and Loss Settlement Basics

The limit of insurance is the most the insurer pays. Limits can be specific (one amount per item/building), blanket (one limit covering several items/locations, giving flexibility), or scheduled (each item listed with its own value).

Loss-settlement options determine how much is paid within the limit. Actual cash value (ACV) equals replacement cost minus depreciation.

Replacement cost (RC) is the cost to repair or replace with like kind and quality, with no depreciation, usually requiring the insured to actually repair/replace and to insure to a coinsurance percentage. Agreed/valued is a stated amount paid for a total loss regardless of depreciation. Worked example: a 10-year-old roof (20-year life) costing $20,000 to replace settles at ACV = $20,000 × (10/20 remaining) = $10,000, but at replacement cost the insurer pays the full $20,000 once the roof is replaced.