2.5 Deductibles and Policy Limits

Deductibles and limits define how much the insured pays versus how much the insurer pays. Understanding these concepts is essential for proper coverage.

What Is a Deductible?

Definition: The amount the insured must pay out-of-pocket before insurance coverage kicks in.

Purpose of Deductibles:

• Eliminate small nuisance claims
• Reduce premium costs
• Encourage loss prevention (insured has "skin in the game")
• Share risk between insured and insurer

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Types of Deductibles

1. Flat Deductible (Per-Occurrence)

Definition: A specific dollar amount that applies to each loss.

Examples: $500, $1,000, $2,500

How It Works:

• Loss: $5,000
• Deductible: $1,000
• Insurance pays: $4,000

Common For: Homeowners, auto, general property policies

2. Percentage Deductible

Definition: A percentage of the covered property value or coverage amount.

Examples: 2%, 5%, 10%, 20%

How It Works:

• Dwelling coverage: $400,000
• Earthquake deductible: 15%
• Deductible amount: $60,000
• If $100,000 earthquake loss: Insured pays $60,000, insurer pays $40,000

Common For: Earthquake, hurricane/wind, flood coverage

3. Aggregate Deductible

Definition: A total deductible amount for all losses during the policy period.

How It Works:

• Annual aggregate deductible: $5,000
• First loss ($2,000): Insured pays $2,000 (remaining aggregate: $3,000)
• Second loss ($4,000): Insured pays $3,000, insurer pays $1,000
• Third loss ($3,000): Insurer pays full $3,000 (aggregate satisfied)

Common For: Commercial policies, umbrella policies

4. Split Deductible

Definition: Different deductible amounts for different perils.

Example:

• All perils: $1,000 flat deductible
• Wind/Hail: 2% of Coverage A
• Earthquake: 15% of Coverage A

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Deductible vs. Premium Trade-off

Rule of Thumb: Increasing your deductible from $500 to $1,000 can reduce premiums by 10-20%.

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Policy Limits

Definition: The maximum amount an insurer will pay for a covered loss.

Types of Limits

1. Per-Occurrence Limit

Maximum payment for any single event/loss.

Example: $300,000 per-occurrence limit

• One fire causes $400,000 damage
• Insurer pays maximum $300,000

2. Aggregate Limit

Maximum total payment for all losses during the policy period.

Example: $1,000,000 annual aggregate

• Multiple claims throughout the year
• Total payments cannot exceed $1,000,000

3. Split Limits

Separate limits for different coverages or categories.

Auto Example: 100/300/100

• $100,000 per person bodily injury
• $300,000 per accident bodily injury
• $100,000 property damage

4. Combined Single Limit (CSL)

One limit covering all damages in an occurrence.

Example: $500,000 CSL

• Covers bodily injury AND property damage
• More flexible than split limits

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Sublimits

Definition: Maximum amounts for specific categories of property that are LOWER than the overall policy limit.

Common Homeowners Sublimits

Example:

• Personal property limit: $150,000
• Jewelry sublimit: $1,500
• $10,000 ring is stolen
• Maximum payment: $1,500 (sublimit applies)

How to Increase Sublimits

• Scheduled Personal Property Endorsement — List specific items with agreed values
• Floater policy — Separate policy for valuables
• Increased sublimit endorsement — Raise category limits

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Limits and Deductibles Working Together

Example Calculation:

Given:

• Policy limit: $250,000
• Deductible: $2,500
• Loss: $100,000

Payment: $100,000 (loss) - $2,500 (deductible) = $97,500 paid by insurer

If Loss Was $300,000: $250,000 (limit, less than loss) - $2,500 (deductible) = $247,500 paid

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Other Insurance Clauses

When multiple policies cover the same loss:

Pro Rata (Contribution by Limits)

Each insurer pays proportionally based on their limit.

Formula: (Policy Limit ÷ Total of All Limits) × Loss

Primary and Excess

One policy pays first (primary), other pays only if primary is exhausted (excess).

Example:

• Homeowners is primary: Pays first $300,000
• Umbrella is excess: Pays amounts above $300,000