2.4 Deductibles, Limits, and Loss Settlement

Deductibles — the Insured's Retention

A deductible is the amount the insured pays out of pocket before the insurer pays. Deductibles eliminate small, frequent claims (which are expensive to administer relative to their size), reduce moral hazard, and lower premiums. The most common property deductible is a flat dollar amount applied per occurrence.

Catastrophe-prone perils often use a percentage deductible based on the Coverage A dwelling limit, not the loss amount. Hurricane, windstorm/hail, and earthquake deductibles of 2% to 20% are typical in exposed regions.

Worked Example — Percentage Deductible

A homeowner has earthquake coverage with a 15% deductible. The dwelling (Coverage A) limit is $200,000, and an earthquake causes $60,000 of damage.

• Deductible = 15% x $200,000 = $30,000 (calculated on the dwelling limit, not the loss)
• Insurer pays = $60,000 − $30,000 = $30,000

The trap: students apply the percentage to the loss ($60,000 x 15% = $9,000) and overstate the payment. Percentage deductibles for wind/quake apply to the coverage limit, producing a much larger retention.

Limits and Sublimits

The limit of insurance is the most the insurer will pay. Property policies layer several limit types:

• Per-occurrence / per-item limit — the cap for one loss event.
• Sublimits — internal caps for high-theft or specialty property within a broader limit. A homeowners Coverage C contents limit may be $150,000, but jewelry theft is sublimited to, say, $1,500 unless scheduled.
• Blanket vs. specific — a specific limit covers one item/location; a blanket limit covers multiple items or locations under one amount.

Exam trap: a $50,000 jewelry loss against a $1,500 theft sublimit pays only $1,500, even though the overall contents limit is far larger. Sublimits are not additional coverage — they are internal restrictions.

Liability Limits and Split Limits

Casualty/liability coverage uses limit structures that appear on the property-and-casualty exam:

• Single limit (CSL) — one combined amount applies to all bodily injury and property damage per occurrence (e.g., $300,000 CSL).
• Split limits — written as three numbers, e.g., 100/300/50 meaning $100,000 per person BI, $300,000 per accident BI, $50,000 per accident property damage.

Split-limit example: With 100/300/50, an at-fault accident injures three people with claims of $80,000, $120,000, and $90,000.

• Person 1: $80,000 (under $100k per-person) → $80,000
• Person 2: capped at the $100,000 per-person limit → $100,000
• Person 3: capped at $100,000 per-person → $100,000
• Total BI = $280,000, within the $300,000 per-accident cap → all $280,000 paid.

Other-Insurance and Loss-Settlement Conditions

When two policies cover the same property, pro rata (contribution by limits) splits the loss in proportion to each policy's limit. Example: Insurer A carries $300,000 and Insurer B carries $100,000 on the same building (total $400,000). On a $40,000 loss, A pays 300/400 x $40,000 = $30,000 and B pays 100/400 x $40,000 = $10,000.

Loss-settlement order on a property claim is generally: (1) apply the valuation method, (2) apply any coinsurance factor, (3) subtract the deductible, (4) cap at the limit/sublimit, (5) coordinate other insurance. Getting the order right is essential — coinsurance is applied to the loss before the deductible is subtracted.

Aggregate Limits and Restoration

Most property policies provide a per-occurrence limit that is not reduced by paying a claim — it resets for the next separate occurrence within the term. Liability and certain commercial coverages, however, add an aggregate limit: the most payable for all covered losses during the policy period. Once the aggregate is exhausted, no further claims are paid even if the per-occurrence limit remains.

The CGL, for instance, carries both a per-occurrence limit and general and products-completed-operations aggregates. On the exam, distinguish a per-occurrence cap (one event) from an annual aggregate (the whole year) — confusing the two changes the answer when multiple losses occur.

Pro Rata vs. Excess and Primary Other-Insurance Rules

When more than one policy applies, the other-insurance condition decides who pays. Three patterns appear on the exam:

A pro rata example: Insurer A $300,000 and Insurer B $100,000 cover a $40,000 loss. A pays 300/400 x $40,000 = $30,000; B pays 100/400 x $40,000 = $10,000. The insured never collects more than the actual loss — the principle of indemnity prevents profit from holding two policies.

Deductible Types and How They Apply

Expect questions distinguishing deductible structures:

• Flat (straight) deductible - a fixed dollar amount subtracted from each loss ($500, $1,000).
• Percentage deductible - common for wind/hail and earthquake; computed as a percent of the dwelling limit (Coverage A), so a 2% deductible on a $300,000 home is $6,000, often far larger than a flat deductible.
• Disappearing (franchise) deductible - the deductible shrinks as the loss grows and vanishes above a threshold.
• Waiting period - the "time deductible" in business income coverage (typically 72 hours) before lost income begins to be paid.

The percentage-deductible math is heavily tested because catastrophe deductibles surprise consumers.

Limits: Per-Occurrence, Aggregate, and Sublimits

A per-occurrence limit caps what the insurer pays for a single event; an aggregate limit caps total payments during the policy period across all occurrences. Liability policies usually carry both, and once the aggregate is exhausted the policy is "burned out" even if per-occurrence limits remain. A sublimit is a smaller internal cap for a specific category (e.g., $1,500 for jewelry theft inside a homeowners policy) - it does not add to the overall limit, it carves out a smaller ceiling within it.

Loss settlement then applies the valuation method, deductible, coinsurance, and any other-insurance provision to arrive at the final payment.