2.4 Deductibles, Limits, and Loss Settlement

Deductibles, Limits, and the Order of Settlement

After cause of loss, valuation, and coinsurance are settled, two contractual constraints shape the final check: the deductible (the insured's retained first dollars) and the limit of insurance (the most the insurer will pay). The exam tests the order of operations — coinsurance first, then deductible, then the limit cap — and the different ways deductibles and limits are structured.

A deductible reduces small claims, lowers premium, and discourages frivolous filings. A limit is the insurer's maximum obligation for a coverage. Misordering these is a frequent error: candidates subtract the deductible before coinsurance, or forget the limit cap on a large loss.

Types of Deductibles

• Flat (straight) deductible — a fixed dollar amount subtracted from each covered loss (e.g., $1,000). Most common in homeowners and commercial property.
• Percentage deductible — a percentage of the limit (or sometimes value), used for wind/hail, hurricane, and earthquake. On a $300,000 dwelling with a 2% wind deductible, the insured retains $6,000 before the insurer pays.
• Calendar-year deductible — an aggregate the insured satisfies once per year (common in health, rare in property).
• Franchise deductible — once the loss exceeds a threshold, the insurer pays the loss in full with no deduction (used in marine/cargo). Contrast with a straight deductible, which is always subtracted.
• Disappearing (diminishing) deductible — shrinks as the loss grows, vanishing above a stated amount.
• Waiting period — a time deductible for business income / extra expense (e.g., 72 hours).

Types of Limits

• Per-occurrence limit — the most paid for any one loss event.
• Aggregate limit — the most paid for all covered losses in the policy period (common in liability and some property catastrophe covers).
• Sublimit — a lower cap within a coverage (e.g., $1,500 on jewelry theft, $2,500 on business property off-premises).
• Blanket limit — one limit covering multiple locations or property types; contrast with specific (scheduled) limits that apply per item/location.
• Split limits in liability (covered fully in casualty units) appear as 25/50/25 — $25,000 per person bodily injury / $50,000 per accident BI / $25,000 property damage. A combined single limit (CSL) is one number covering BI and PD together.

Worked split-limit example. With 25/50/25 limits, an at-fault auto accident injures three people ($30,000, $20,000, $15,000) and causes $30,000 property damage. BI per person caps the first claim at $25,000 (not $30,000); the others pay $20,000 and $15,000 = $60,000 of BI — but the per-accident BI cap is $50,000, so BI pays only $50,000. Property damage is capped at $25,000 (not $30,000). Insurer pays $50,000 + $25,000 = $75,000; the insured owes the rest personally.

Putting It Together — Order of Operations

For a property loss with coinsurance and a deductible, settle in this fixed order:

1. Determine the loss amount using the valuation clause (ACV or RC).
2. Apply the coinsurance factor (Did/Should) if the insured is underinsured.
3. Subtract the deductible.
4. Cap the result at the policy limit / sublimit.

Example. RC building valued at $400,000; 80% coinsurance (Should = $320,000); insured carries $240,000 (Did); loss = $80,000; deductible = $2,000; limit = $240,000.

• Ratio = $240,000 / $320,000 = 0.75
• Indemnity = 0.75 × $80,000 = $60,000
• Less deductible = $60,000 − $2,000 = $58,000
• Below the $240,000 limit → insurer pays $58,000.

Deductible Types and How They Interact With Limits

A deductible is the insured's retained portion of each loss, applied after any coinsurance calculation and before the limit cap.

Property forms use several deductible structures the exam tests: a flat (straight) dollar deductible subtracted from each covered loss; a percentage deductible (common for windstorm, hail, and named-storm exposures) calculated as a percentage of the Coverage A limit, not the loss — so a 2% wind deductible on a $300,000 dwelling is $6,000 regardless of loss size; and a disappearing/franchise deductible, less common today, where the insurer pays nothing until a threshold is reached, then pays in full.

Higher deductibles lower premium by eliminating small, high-frequency claims and aligning the insured's incentive to prevent loss. On catastrophe-exposed property, percentage deductibles transfer more of the frequent, weather-driven losses back to the insured, which is why they are standard in tornado- and hurricane-prone regions.

Limits of Insurance, Sub-Limits, and Loss Settlement Order

The limit of insurance is the maximum the insurer pays for covered loss to the described property; it is not reduced by paying a claim under most occurrence-based property forms (it reinstates for the next loss), unlike an aggregate-limited liability policy. Within that overall limit, sub-limits cap specific categories — money and securities, jewelry, firearms, business property in a homeowners form — even when the main limit is far higher; scheduling items by endorsement raises or removes the sub-limit.

The correct order of operations at claim time is the exam's favorite trap: (1) determine the loss amount on the applicable valuation basis (RC or ACV); (2) apply any coinsurance factor; (3) subtract the deductible; (4) cap the result at the policy limit (and any sub-limit). Reversing steps 2 and 3 — subtracting the deductible before coinsurance — produces a wrong answer and is a deliberate distractor in many questions.