2.4 Deductibles, Limits, and Loss Settlement

2.4 Deductibles, Limits, and Loss Settlement

A deductible is the portion of a loss the insured retains before the insurer pays. Deductibles reduce moral/morale hazard, eliminate small nuisance claims, and lower premium. The national exam tests several deductible structures and how they interact with limits.

Flat, percentage, and special deductibles

• Flat (straight) deductible — a fixed dollar amount subtracted from each loss (e.g., $500, $1,000).
• Percentage deductible — a percent of the policy limit (or sometimes of the property value), common for wind/hail and named-storm coverage in catastrophe-prone states (e.g., a 2% hurricane deductible on a $300,000 dwelling = $6,000).
• Disappearing deductible — shrinks as the loss grows and vanishes above a threshold (rare today).
• Aggregate deductible — applies once across the policy term rather than per occurrence.

Policy limits and how they cap recovery

The limit of insurance is the maximum the insurer will pay. Limits come in several forms:

• Per-occurrence limit — most paid for a single event.
• Aggregate limit — most paid over the policy term across all occurrences (common in liability).
• Sublimits / special limits of liability — internal caps for theft-prone categories (e.g., HO special limits: $200 cash, $1,500 jewelry theft, $2,500 business property).
• Split limits (liability) — separate caps such as 100/300/50: $100,000 per person bodily injury, $300,000 per accident BI, $50,000 property damage.
• Combined single limit (CSL) — one figure covering BI and PD together.

Worked split-limit example

An auto policy is written 100/300/50 ($100,000 / $300,000 / $50,000). The insured causes an at-fault accident injuring three people — claims of $90,000, $120,000, and $60,000 — plus $70,000 in property damage.

Each person is capped at $100k; total BI is then capped at $300k; PD is separately capped at $50k. Amounts above the limits are the insured's personal responsibility.

Loss settlement order of operations

When multiple provisions stack, apply them in this order: (1) confirm the peril is covered; (2) apply the valuation method (ACV vs. RC) to size the loss; (3) apply the coinsurance ratio if underinsured; (4) subtract the deductible; (5) cap at the policy limit / sublimit. Reversing steps 3 and 4 (deductible before coinsurance) is the most common arithmetic error and a deliberate distractor.

Worked Hurricane Percentage-Deductible Example

Percentage deductibles dominate catastrophe coverage and appear on the Hawaii portion as hurricane deductibles. A dwelling insured for $400,000 carries a 2% named-storm deductible. A hurricane causes $60,000 of covered damage.

Note the deductible is figured on the limit, not the loss, so a 2% hurricane deductible is far larger than a typical flat $500 all-other-perils deductible.

CSL vs. Split Limits Trade-Off

A combined single limit is more flexible than split limits because one pool covers all bodily injury and property damage per accident. Under a $300,000 CSL the three-person/PD claim above totaling $340,000 would still cap at $300,000, but the insurer could allocate the full amount without a separate per-person sublimit choking one large claim. The exam may ask which structure best protects an insured facing one catastrophic injury - the answer is CSL.

Exam summary: Order of operations is peril -> valuation -> coinsurance -> deductible -> limit. Percentage deductibles are figured on the limit. Split limits cap per person, per accident, and PD separately; CSL pools them.

Aggregate vs. Per-Occurrence Limits

Liability policies stack two limits the exam tests together. The per-occurrence limit caps a single event; the aggregate caps total payments across the policy term. Once the aggregate is exhausted, no further claims are paid even if the per-occurrence limit would otherwise apply. Property policies more often use a single per-occurrence limit with internal sublimits.

Reading a Limits Question

When a question lists several claims against a 100/300/50 policy, attack it in three passes: cap each bodily-injury claimant at the per-person figure, sum the capped BI claims and cap that total at the per-accident figure, then handle property damage against its own separate limit. Anything above the limits is the insured's personal exposure - exactly the gap a personal umbrella policy is designed to fill. Spelling out the three passes prevents the common error of applying the per-accident limit to a single claimant.

Why Deductibles and Limits Are Tested Together

Deductibles set the floor of a claim and limits set the ceiling, so the exam pairs them to test whether you can size a payment from both ends. A flat deductible is simple subtraction; a percentage deductible must be computed from the limit first; an aggregate limit can shut off coverage mid-term. Treat every settlement question as a pipeline - confirm coverage, value the loss, apply coinsurance, subtract the deductible, then cap at the limit or sublimit - and the deductible and limit each take their proper place. This disciplined order is the difference between a confident answer and a guessed one on the calculation items.