2.4 Deductibles, Limits, and Loss Settlement
Key Takeaways
- Deductibles reduce premium and small claims; types include flat, percentage, franchise, disappearing, and waiting-period.
- Percentage (wind/hurricane) deductibles apply to the dwelling LIMIT, not the loss amount.
- Franchise deductibles pay nothing until a threshold, then pay the full loss.
- Settlement order: covered peril, valuation, coinsurance factor, deductible, then policy-limit cap.
- The policy limit and the actual loss both cap the final payment.
Deductibles: The Insured's Retained Loss
A deductible is the portion of each covered loss the insured retains before the insurer pays. Deductibles reduce premium, eliminate small nuisance claims, and reduce moral/morale hazard. The property exam tests several deductible structures and how each interacts with the policy limit and coinsurance.
Deductible Types
| Type | How It Works |
|---|---|
| Flat (straight) | A fixed dollar amount subtracted from each loss ($1,000 per occurrence) |
| Percentage | A percent of the limit or property value — common for wind/hail and hurricane (2%–5%); produces large retentions |
| Franchise | Insurer pays nothing until the loss exceeds a threshold, then pays the full amount (common in ocean marine) |
| Disappearing | Deductible shrinks as the loss grows and vanishes at a stated point |
| Waiting period | A time deductible used in business income (e.g., 72 hours) before indirect loss is paid |
Percentage (Hurricane/Wind) Deductible Math
A Florida-style 5% hurricane deductible applies to the dwelling limit, not the loss. On a home insured for $400,000 with a $30,000 wind loss:
Deductible = 5% × $400,000 = $20,000
Payment = $30,000 − $20,000 = $10,000
The insured retains $20,000 even though the loss was only $30,000 — a frequent shock to policyholders and a tested point. A flat $1,000 deductible on the same loss would pay $29,000.
Limits and the Order of Loss Settlement
The policy limit is the maximum payable for covered property; per-occurrence and aggregate limits cap exposure. The settlement sequence on a property loss is testable:
- Confirm a covered peril caused direct physical loss to covered property.
- Determine the valuation basis (ACV or RC).
- Apply the coinsurance factor to a partial loss.
- Subtract the deductible.
- Cap the result at the policy limit.
Order matters: coinsurance is applied to the loss before the deductible, and the limit caps the final figure. Other-insurance clauses (pro rata, contribution by equal shares) then allocate among multiple policies.
Aggregate, Per-Occurrence, and Sublimits
Beyond the single deductible, the exam tests how limits stack. A per-occurrence limit caps one event; an aggregate limit caps the total the policy will pay during the term regardless of the number of events. Sublimits carve out a smaller cap inside the policy limit for specific property — money and securities, valuable papers, or a special-class personal-property category under a homeowners form. When a sublimit and the overall limit both apply, the sublimit controls for that property even though room remains under the policy limit.
Other-Insurance Provisions and How They Allocate
When more than one policy covers the same loss, the other-insurance condition determines payment. Pro rata by limits allocates each insurer's share as its limit divided by total limits. Contribution by equal shares has each insurer pay equally until the smaller limit exhausts, then the larger continues alone. Primary and excess designations make one policy respond first and the other only after the primary limit is used up. An escape (no-liability) clause tries to avoid paying entirely if other coverage exists.
Memorize that property forms generally use pro rata, while many liability and excess situations use primary-and-excess logic.
Worked Settlement Combining Coinsurance and Deductible
Put the full sequence together. A building worth $1,000,000 carries an 80% coinsurance clause (Should Carry $800,000) but is insured for only $600,000 with a $2,500 deductible. A covered fire causes a $200,000 partial loss.
Ratio = $600,000 / $800,000 = 0.75
Penalized loss = 0.75 x $200,000 = $150,000
Less deductible = $150,000 - $2,500 = $147,500 paid
The insured absorbs $52,500 — $50,000 from the coinsurance penalty and $2,500 from the deductible — illustrating why the order (penalty, then deductible, then cap) is tested. Had this been a total loss, the policy would simply pay its $600,000 limit less the deductible, because coinsurance penalties never apply to a total loss and the limit is the ceiling.
Replacement-Cost Holdback in the Settlement Sequence
When a building is settled on replacement cost, fold the ACV holdback into the sequence. The insurer first pays ACV (replacement cost minus depreciation) less the deductible, then releases the withheld recoverable depreciation after the insured completes repairs and submits proof, usually within 180 days. If the insured never rebuilds, the settlement stays at ACV permanently. Combine this with sublimits and you can trace why two policies with identical limits pay different amounts on the same loss: valuation basis, coinsurance compliance, deductible size, and whether repairs are actually made all move the final number.
Franchise and Disappearing Deductibles Revisited
A franchise deductible pays nothing until the loss reaches the threshold, then pays in full — so a $1,000 franchise pays $0 on a $900 loss but $5,000 on a $5,000 loss. A disappearing deductible shrinks as the loss grows and reaches zero at a stated ceiling. These appear most often in ocean marine and older property forms, and the exam contrasts their payouts against a flat deductible on the same loss to confirm you understand the mechanics.
Why Identical Limits Pay Differently
Summarize the levers that change a payout even when two policies show the same limit: (1) valuation basis (ACV vs. RC), (2) coinsurance compliance at the time of loss, (3) deductible type and size, (4) whether the insured actually repairs to release recoverable depreciation, (5) sublimits on special property, and (6) other-insurance allocation when policies overlap. Walking a stem through these six levers in order produces the correct settlement and exposes the distractor answers that skip a step.
A home is insured for $300,000 with a 2% hurricane deductible. A covered windstorm causes $25,000 of damage. What does the insurer pay?
In settling a partial property loss subject to coinsurance, what is the correct order of operations?