2.4 Deductibles, Limits, and Loss Settlement

Deductibles: The Insured's Retention

A deductible is the amount of each loss the insured retains before the insurer pays. Deductibles control moral/morale hazard, eliminate small claims, and lower premium. The exam tests the types of deductibles and the order of operations against coinsurance and limits.

Types you must know:

• Straight (flat) deductible — a fixed dollar amount subtracted from each loss ($500, $1,000, $2,500). The default on most property forms.
• Percentage deductible — a percent of the dwelling limit (not the loss), common for wind/hail and earthquake (e.g., 2% of a $300,000 limit = $6,000).
• Aggregate / calendar-year deductible — the insured retains losses until a total annual threshold is reached, then the insurer pays the rest.
• Franchise deductible — once the loss exceeds the threshold, the insurer pays in full with no deduction (common in marine/agriculture).

Worked Example — Percentage Wind Deductible

A coastal home has a $400,000 dwelling (Coverage A) limit and a 2% named-storm deductible. A hurricane causes $50,000 of covered wind damage.

• Deductible = 2% × $400,000 (the limit, not the loss) = $8,000.
• Insurer pays $50,000 – $8,000 = $42,000.

Trap: the percentage is applied to the Coverage A limit, not the loss amount. Candidates routinely compute 2% of $50,000 = $1,000 — wrong. Percentage hurricane/earthquake deductibles are far larger than a flat deductible and are a frequent source of consumer complaints, so states require clear disclosure.

Limits of Insurance and Sublimits

The limit of insurance is the most the insurer will pay for a covered loss. Property structures include:

• Per-occurrence / blanket limits — a single limit covering multiple buildings or coverages.
• Sublimits — reduced internal caps (e.g., HO special limits: $200 money, $1,500 watercraft, $2,500 business property on premises).
• Specific vs. blanket: a specific limit applies to one item/location; a blanket limit applies across several and avoids coinsurance penalties from misallocation.

Liability limits use split limits vs. a combined single limit (CSL). Read 25/50/15 as $25,000 bodily injury per person / $50,000 BI per accident / $15,000 property damage per accident. A CSL of $100,000 can be applied to any mix of BI and PD up to $100,000 per accident.

Split-Limit Worked Example

An auto policy carries 25/50/15. An at-fault accident injures three people — claims of $20,000, $30,000, and $15,000 — plus $18,000 in property damage.

Person 2 is short $5,000 (per-person cap) and the BI total hits the $50,000 per-accident cap; PD is short $3,000. The insured is personally liable for the uncovered $8,000+. This double-cap structure (per person and per accident) is heavily tested.

Deductible Types You Must Distinguish

How Limits Apply

A per-occurrence limit caps a single event; an aggregate caps all losses in the term; a split limit caps each injured person and the whole accident; and a combined single limit (CSL) provides one pooled figure for bodily injury and property damage together. Candidates must convert split limits to dollars: a 100/300/50 auto policy pays up to $100,000 per person, $300,000 per accident for injuries, and $50,000 for property damage.

Sublimits and Special Limits of Liability

Inside a single coverage, sublimits cap categories that are easy to overstate or steal - jewelry, firearms, money, and business property in a homeowners Coverage C. A sublimit reduces, it does not add to, the overall limit. A common trap shows a $300,000 contents limit but a $1,500 theft sublimit on jewelry; only $1,500 is payable for a stolen ring.

Restoration, Nonreduction, and Reinstatement

Most property limits are nonreducing within the term - paying a partial claim does not shrink the remaining limit. By contrast, aggregate limits in liability forms do erode as claims are paid, which is why a reinstatement provision or a higher aggregate matters. Knowing which limits restore automatically and which erode is a recurring multiple-choice distinction.

Disappearing Deductibles and Self-Insured Retentions

Two further structures appear on exams. A disappearing (diminishing) deductible shrinks as the loss grows and vanishes entirely above a threshold - rewarding the insured on large losses while retaining small-claim screening.

A self-insured retention (SIR) differs from a deductible: with a deductible the insurer pays the full loss and bills back the deductible, but with an SIR the insured pays and handles the loss within the retention before the insurer's coverage and duty to defend even attach. Knowing that an SIR usually sits below an umbrella's drop-down coverage, while a deductible sits inside a primary policy, is a frequently tested distinction.