2.4 Deductibles, Limits, and Loss Settlement
Key Takeaways
- Deductibles can be flat, percentage (common for hurricane/earthquake), aggregate, franchise, or a business-income waiting period.
- A franchise deductible pays the full loss once the threshold is exceeded; a straight deductible is always subtracted.
- ISO special theft sublimits: money $200, securities $1,500, jewelry $1,500, firearms $2,500, silverware $2,500 — schedule valuables to exceed them.
- Coverage A settles at replacement cost only if the insured carries at least 80% of full RC; Coverage C settles at ACV unless endorsed.
- The pair-and-set clause lets the insurer pay the loss in value to a set rather than replace the whole set.
Deductibles: The Insured's Retention
A deductible is the amount the insured retains on each loss before the policy responds. Deductibles reduce premium, eliminate small nuisance claims, and reduce moral/morale hazard by giving the insured a financial stake. The exam distinguishes several structures and tests the arithmetic on each.
Types of Deductibles
| Type | How it works |
|---|---|
| Flat (straight) | A fixed dollar amount subtracted from each loss (e.g., $1,000). |
| Percentage | A % of the dwelling limit — common for hurricane/windstorm and earthquake (e.g., 2% of Coverage A). |
| Aggregate | Applies once per policy period across all losses, not per occurrence. |
| Disappearing | Shrinks as the loss grows and vanishes above a threshold (rare today). |
| Franchise | Once the loss exceeds the franchise amount, the FULL loss is paid with NO deduction. |
| Waiting period | A time deductible used in business income — typically a 72-hour period before coverage begins. |
Percentage-deductible trap: a 2% hurricane deductible on a $300,000 dwelling is $6,000 — far larger than the flat all-other-perils deductible, surprising many insureds after a storm.
Policy Limits, Sublimits, and Special Limits
The limit of insurance is the most the insurer pays for a covered loss. Within homeowners forms, ISO imposes special limits of liability (sublimits) on theft-prone or high-value categories. These limits apply to the peril of theft in particular and are commonly tested:
| Category | Typical special limit |
|---|---|
| Money, coins, bank notes | $200 |
| Securities, deeds, manuscripts | $1,500 |
| Jewelry, watches, furs (theft) | $1,500 |
| Firearms (theft) | $2,500 |
| Silverware/goldware (theft) | $2,500 |
| Business personal property (on premises) | $2,500 |
To cover above these sublimits, the insured schedules the items (an HO-15 or a Personal Articles Floater / inland marine endorsement), which also broadens coverage to open-peril and often waives the deductible.
Loss Settlement Provisions
Loss settlement language tells how the limit is applied:
- Coverage C personal property is settled at ACV under base HO forms unless a replacement-cost endorsement is added.
- Coverage A dwelling is settled at replacement cost IF the insured carries at least 80% of full replacement value at the time of loss — this 80% requirement is the homeowners version of coinsurance. Carry less than 80%, and the insurer pays the larger of ACV or the proportion (limit / 80% of RC) × loss.
- Pair-and-set clause: for a damaged item that is part of a set, the insurer may repair/replace the set or pay the difference between the ACV of the set before and after — it is NOT required to replace the entire set.
Worked Example — Combining Deductible and Limit
A homeowner with a $250,000 Coverage A limit (carrying ≥ 80% RC, so RC settlement applies) suffers a kitchen fire. The repair (replacement cost) is $40,000; the policy has a $2,500 flat deductible.
- Settlement basis: Replacement Cost (80% test met)
- Payment = $40,000 − $2,500 = $37,500
Now assume a separate theft of a $4,000 ring from the same home with NO scheduled endorsement. The theft special limit on jewelry is $1,500, so the recovery is capped at $1,500 regardless of the dwelling deductible — illustrating why scheduling valuables matters.
A homeowner suffers an unscheduled theft of a $4,000 ring under a standard HO policy. What is the maximum the policy will pay for the jewelry?
Under a franchise deductible, what does the insurer pay once the loss exceeds the franchise amount?
Deductible Types and When Each Applies
The exam tests several deductible structures:
| Type | How it works | Common line |
|---|---|---|
| Straight (flat) | Fixed dollar amount per occurrence | Auto, property |
| Percentage | A percent of the limit or value (e.g., 2% wind/hail) | Coastal property, earthquake |
| Aggregate | Insured absorbs losses up to a yearly total, then full coverage | Commercial property |
| Franchise | No payment until loss exceeds a threshold, then full loss paid | Ocean marine |
| Waiting period | A time-based deductible | Business income (e.g., 72 hours) |
Worked percentage example: A coastal home insured for $400,000 has a 2% wind deductible. A hurricane causes $50,000 of wind damage. The deductible is 2% x $400,000 = $8,000, so the insurer pays $42,000. Note the deductible is figured on the limit, not the loss.
Limits, Sublimits, and the Order of Settlement
A per-occurrence limit caps each loss; an aggregate limit caps total annual payments. Sublimits restrict specific property within a larger limit (a $2,500 cap on business records, a $1,500 special limit on jewelry theft). When solving "how much is paid," apply the steps in order: determine the covered amount (lesser of loss or applicable sublimit), apply the coinsurance ratio if property and partial, subtract the deductible, then cap at the limit of insurance.
Combined worked example: Loss to scheduled property valued at $30,000; special limit $25,000; deductible $1,000. The recovery is capped at the $25,000 sublimit, then reduced by the $1,000 deductible = $24,000, even though the actual loss was $30,000. Recognizing which figure controls — loss, sublimit, coinsurance result, or policy limit — is the entire skill the question is measuring.
Loss Settlement and the Role of the Limit
Two settlement clauses interact with deductibles and limits. Replacement-cost settlement pays the cost to repair or replace without depreciation but normally only after the insured actually replaces, releasing the held-back recoverable depreciation in a second payment. Actual-cash-value settlement subtracts depreciation up front.
The limit of insurance is the absolute ceiling: no combination of coverages pays beyond it for a single loss except where additional coverages are stated to be in addition to the limit (debris removal, fire-department service charge). When stacking the math, remember the deductible is subtracted last, after the covered amount and any coinsurance result are determined, and the answer can never exceed the applicable limit.