2.4 Deductibles, Limits, and Loss Settlement
Key Takeaways
- A deductible is the amount the insured retains per loss; it lowers premium, reduces small claims, and shares the risk.
- Percentage deductibles (hurricane, wind/hail, earthquake) are figured on the dwelling limit, not the loss, and dwarf flat deductibles.
- Policy limits cap the insurer's payment; sublimits restrict specific categories such as jewelry, cash, or business records.
- Loss settlement order is typically: determine covered loss, apply valuation, apply coinsurance, then subtract the deductible, never exceeding the limit.
- Other-insurance provisions (pro rata, primary/excess, contribution by equal shares) prevent the insured from profiting when two policies overlap.
Deductibles
A deductible is the portion of each covered loss the insured pays first. It lowers premium, eliminates small nuisance claims, and gives the insured a stake in preventing loss. The exam distinguishes two structures:
| Type | How it is calculated | Where used |
|---|---|---|
| Flat (dollar) deductible | Fixed amount, e.g., $500 or $1,000 | Most property and auto policies |
| Percentage deductible | Percent of the dwelling limit, e.g., 2% or 5% | Hurricane, wind/hail, earthquake |
Worked example: A $400,000 home with a 5% hurricane deductible carries a $20,000 deductible (0.05 x $400,000), not 5% of the loss. Candidates often wrongly apply the percentage to the loss.
Limits and Sublimits
The policy limit is the most the insurer will pay. Distinguish:
- Per-occurrence limit caps a single event.
- Aggregate limit caps total payments over the policy term.
- Sublimit caps a specific category within the overall limit, such as $1,500 on jewelry theft or $200 on cash under a homeowners policy.
Scenario: A homeowners policy has $100,000 contents coverage but a $1,500 sublimit on jewelry. A burglar takes a $6,000 ring; the policy pays only $1,500 for the ring because the sublimit, not the overall contents limit, controls. Scheduling the item raises that sublimit.
Order of Loss Settlement
Applying the steps in the wrong order produces the wrong answer. The standard sequence is:
- Confirm the loss is covered (peril and property).
- Apply the valuation method (ACV, RC, functional).
- Apply the coinsurance factor if applicable.
- Subtract the deductible.
- Cap the result at the policy limit.
Worked example: Covered loss $50,000, ACV basis, coinsurance ratio 0.90, deductible $1,000, limit $80,000. Settlement = $50,000 x 0.90 = $45,000, minus $1,000 = $44,000, which is under the $80,000 limit, so $44,000 is paid.
Other-Insurance Provisions
When two policies cover the same loss, other-insurance clauses stop the insured from collecting more than the loss (the principle of indemnity).
| Method | How it shares | Example |
|---|---|---|
| Pro rata | Each insurer pays its share of total limits | Two equal limits split the loss 50/50 |
| Primary and excess | One pays first; the other pays above its limit | Excess layer over a primary policy |
| Contribution by equal shares | Each pays equally until one limit is exhausted | Liability policies of differing limits |
Pro rata math: Policy A limit $100,000, Policy B limit $300,000, total $400,000. On a $40,000 loss, A pays 100/400 x $40,000 = $10,000 and B pays $30,000.
Special Limit Categories and Scheduling
Homeowners forms cap theft-prone or easily concealed property with internal sublimits, because such items are hard to value and tempting to inflate.
| Category | Typical special limit |
|---|---|
| Money, coins, bullion | $200 |
| Securities, manuscripts | $1,500 |
| Jewelry, watches, furs (theft) | $1,500 |
| Firearms (theft) | $2,500 |
| Silverware (theft) | $2,500 |
To cover these fully, the insured schedules the item on a personal articles floater or endorsement, which raises the limit to an agreed value and often broadens the perils to open-peril coverage with no deductible.
Deductibles and the Cost-of-Risk Tradeoff
Raising a deductible lowers premium because the insured retains more small losses, but it increases out-of-pocket exposure on every claim. The exam frames this as the insured sharing the risk, which also reduces moral and morale hazard.
Disappearing deductible is an older concept worth recognizing: the deductible shrinks as the loss grows and vanishes entirely above a threshold. Most modern property policies instead use a straight (flat) deductible applied to every loss, or a percentage deductible for catastrophe perils such as wind, hail, hurricane, and earthquake.
Aggregate Limits and Reinstatement
Where a policy carries an aggregate limit, multiple losses in a term draw down a shared ceiling. Once exhausted, no further payment is made even if the per-occurrence limit has room.
Scenario: A commercial policy has a $1,000,000 per-occurrence limit and a $2,000,000 aggregate. Three separate $800,000 losses occur. The first two pay $800,000 each ($1,600,000 total); the third is capped at the remaining $400,000 of aggregate. Some policies offer reinstatement of limits after a loss, sometimes automatically with additional premium, restoring the limit for future occurrences in the same term.
Putting the Settlement Steps Together
The combined effect of valuation, coinsurance, deductible, and limit can be summarized as a single ordered calculation. Work it in this order every time:
| Step | Action | Example value |
|---|---|---|
| 1 | Confirm covered loss | $60,000 |
| 2 | Apply valuation (ACV/RC) | $60,000 |
| 3 | Apply coinsurance ratio (0.95) | $57,000 |
| 4 | Subtract deductible ($2,000) | $55,000 |
| 5 | Cap at limit ($100,000) | $55,000 paid |
Reversing steps 3 and 4, or applying the deductible before the coinsurance penalty, produces a wrong answer that often appears as a distractor.
How Deductibles, Limits, and Sublimits Interact
A single claim can touch all three controls at once, and the exam likes to combine them. Consider a homeowners theft of a $5,000 watch and $3,000 of electronics under a policy with $100,000 contents coverage, a $1,500 jewelry sublimit, and a $1,000 deductible.
- Watch: limited to the $1,500 jewelry sublimit, not its $5,000 value.
- Electronics: $3,000, within the overall contents limit.
- Recoverable before deductible: $1,500 + $3,000 = $4,500.
- After the $1,000 deductible: $3,500 paid.
The sublimit bites first on the watch, the overall limit is never threatened, and the single deductible applies once to the whole occurrence rather than to each item.
A coastal home insured for $500,000 has a 2% hurricane deductible. A hurricane causes $60,000 of covered damage. How much will the insured pay out of pocket as the deductible?
Policy A has a $200,000 limit and Policy B has a $200,000 limit, both with pro rata other-insurance clauses, covering the same $30,000 loss. How much does each insurer pay?