2.4 Deductibles, Limits, and Loss Settlement

Deductibles: the Insured's Retention

A deductible is the portion of each covered loss the insured pays before the insurer pays anything. It lowers premium, eliminates costly small claims, and keeps the insured financially invested in preventing loss. On most property policies the deductible is a flat dollar amount subtracted from the settlement. Deductibles also reduce moral and morale hazard by ensuring the insured shares in every loss.

Raising a deductible lowers premium because the insured retains more of the small, frequent losses that are expensive for an insurer to adjust. A waiting-period deductible works on time rather than dollars: business income and additional-living-expense coverages often start paying only after a set number of hours or days. The exam contrasts the flat dollar deductible with the percentage deductible used on catastrophe perils.

A few specialty coverages use a disappearing (franchise) deductible that shrinks as the loss grows and vanishes entirely above a threshold, but the flat and percentage forms dominate property exams. Auto physical-damage coverage applies its deductible per occurrence to collision and comprehensive separately, so a single accident that also cracks the windshield can involve two deductibles. Always match the deductible type to the coverage in the question before subtracting.

Percentage Deductibles

Catastrophe-prone coverages use percentage deductibles instead of flat dollars. A hurricane, windstorm, or earthquake deductible is calculated as a percentage of the dwelling limit (Coverage A) — not the loss. A 2% deductible on a $400,000 home equals $8,000 out of pocket, regardless of whether the loss is $20,000 or $200,000. This is a frequent exam trap.

A hurricane deductible is often triggered only when the National Weather Service declares a named storm, after which a higher percentage applies; outside that trigger the ordinary flat wind deductible governs. Earthquake policies almost always use percentage deductibles, frequently 10% to 25% of the limit, reflecting the catastrophic, correlated nature of quake losses. Candidates should always check whether a deductible is figured on the limit or on the loss before computing the retained amount.

Common Deductible Types

Policy Limits

The policy limit is the maximum amount the insurer will pay for a covered loss. A claim that exceeds the limit is paid only up to that ceiling — the insured absorbs the excess. Limits may be per occurrence, aggregate (a cap for the whole policy period), or sub-limits that restrict payment for narrow categories.

Some forms restore coverage automatically after a loss because property limits are typically non-aggregating — each new occurrence has the full limit available. Liability policies, by contrast, more often carry an annual aggregate that erodes as claims are paid. A blanket limit covers multiple buildings or property types under a single combined amount, giving the insured flexibility to apply the limit wherever the loss occurs.

Sub-Limits and Special Limits

Homeowners forms impose special limits on theft-prone or high-value property even though it is otherwise covered. Typical caps include roughly $1,500-$2,500 on jewelry/watches/furs for theft, $200 on money, and $2,500 on business property on premises. Scheduling these items on an endorsement restores full value.

A scheduled personal property endorsement (a personal articles floater) lists each high-value item with its own limit, removes the theft sub-limit, and usually adds open-peril coverage with no deductible. The exam distinguishes a sub-limit (a reduced cap within an existing coverage) from a separate coverage limit (a distinct insuring amount, such as Coverage C personal property under a homeowners policy). Knowing which limit applies to which property is a recurring test theme.

The Loss-Settlement Sequence

Apply the steps in this order:

1. Adjust the loss for coinsurance (if any).
2. Subtract the deductible.
3. Cap the result at the policy limit.

Worked example: $80,000 covered loss; coinsurance met (no penalty); $2,500 deductible; $100,000 limit. Settlement = $80,000 - $2,500 = $77,500, well under the limit, so the insured receives $77,500.

Now add a coinsurance penalty to see the full sequence. Building value $500,000; 80% coinsurance; limit carried $300,000; loss $100,000; deductible $1,000. Amount Required = $400,000; ratio = $300,000 / $400,000 = 75%; coinsurance payment = 75% x $100,000 = $75,000; subtract the $1,000 deductible = $74,000; that is under the $300,000 limit, so the insured collects $74,000. Always run coinsurance first, deductible second, limit last.

Restoration of Limits and Reinstatement

After a property loss is paid, most homeowners and commercial property forms automatically reinstate the full limit for the next occurrence — the policy is not reduced by the amount paid. This differs from many liability policies, where an annual aggregate can be exhausted by claims and must be renewed. When a question asks how much is available for a second loss in the same year, property limits are generally restored, while an eroded liability aggregate is not.

Two extra-cost provisions also affect the limit. Ordinance or law coverage pays the added cost of rebuilding to current building codes, which a standard limit excludes. Extended and guaranteed replacement cost endorsements add a cushion, commonly 25%, above the dwelling limit so a severe loss is not capped short of full rebuilding. Knowing these limit-extending endorsements rounds out the deductibles-and-limits topic the exam covers.