2.5 Deductibles and Policy Limits

Deductibles — the Insured's Retention

A deductible is the amount the insured pays out of pocket before the insurer pays. Deductibles eliminate small nuisance claims that cost more to adjust than to pay, reduce premium, share risk, and give the insured "skin in the game" to prevent losses.

Four Types of Deductibles

Flat example: $5,000 loss with a $1,000 flat deductible → insurer pays $4,000.

Percentage example: $400,000 dwelling coverage, 15% earthquake deductible = $60,000 retained. On an $80,000 quake loss the insurer pays only $20,000. Percentage deductibles are why catastrophe losses leave owners with huge out-of-pocket costs.

Aggregate example: $5,000 annual aggregate — a $2,000 loss (insured pays $2,000), then a $4,000 loss (insured pays the remaining $3,000, insurer pays $1,000), then a $3,000 loss (insurer pays all $3,000 once the aggregate is met).

Deductible-Premium Trade-off

Raising a deductible from $500 to $1,000 commonly trims premium 10-20%.

Policy Limits

The limit is the most the insurer will pay. Four structures appear on the exam.

Split-limit detail (100/300/100): $100,000 bodily injury per person, $300,000 bodily injury per accident, $100,000 property damage. CSL is more flexible because one pool covers any mix of bodily injury and property damage.

Sublimits

A sublimit caps a specific property category below the overall limit. They are a frequent exam trap because the large personal-property limit is irrelevant once a sublimit applies.

Worked example: $150,000 personal-property limit, $1,500 jewelry sublimit. A $10,000 ring is stolen → the insurer pays only $1,500. To fully cover valuables, use a scheduled personal property endorsement, a floater, or an increased-sublimit endorsement.

Limit and Deductible — Order of Operations

Apply the limit first, then subtract the deductible.

• Limit $250,000, deductible $2,500, loss $100,000 → $100,000 − $2,500 = $97,500 paid.
• Limit $250,000, deductible $2,500, loss $300,000 → cap at $250,000, then − $2,500 = $247,500 paid.

Other-Insurance Clauses

When two policies cover the same loss:

• Pro rata (contribution by limits): each insurer pays (its limit ÷ total of all limits) × loss. Two insurers with $100,000 and $300,000 limits on a $40,000 loss pay $10,000 and $30,000 respectively.
• Primary and excess: the primary policy pays first; the excess (such as an umbrella) pays only after the primary limit is exhausted.
• Excess (escape) and other-insurance subtleties: some clauses make a policy strictly excess over any other collectible insurance, while others coordinate so no insured profits from duplicate coverage — the principle of indemnity caps total recovery at the actual loss no matter how many policies respond.

Special Deductible Mechanics: Disappearing and Franchise

Beyond the four core types, two legacy structures still appear as exam distractors. A franchise deductible pays nothing until the loss reaches the franchise amount, then pays the entire loss with no deduction — common historically in ocean marine. A disappearing (diminishing) deductible shrinks as the loss grows: the insurer applies a factor so that above a certain loss size the deductible reaches zero and the full loss is paid. Contrast both with the ordinary straight (flat) deductible, which is always subtracted regardless of loss size.

The exam tests whether you can match the behavior to the name — for example, recognizing that a clause paying the full loss once a threshold is crossed is a franchise deductible, not a flat one.

Hurricane and Named-Storm Deductibles

In coastal states, percentage deductibles get their own trigger language. A hurricane deductible (a percent of Coverage A) applies only when the National Hurricane Center declares a hurricane, and the trigger window is defined by statute or policy — often from the time a hurricane watch or warning is issued until a set number of hours after it ends. A broader named-storm or windstorm deductible can apply to tropical storms as well.

Because these are percentage deductibles on the full dwelling limit, a 5% hurricane deductible on a $400,000 home is $20,000 out of pocket before coverage responds, and many states require the deductible amount and trigger to be disclosed prominently on the Declarations.

Putting Limits, Sublimits, and Deductibles in Order

The safest claims sequence is: (1) confirm the loss is covered, (2) identify the applicable limit or sublimit and cap the loss to it, (3) apply any coinsurance factor, and (4) subtract the deductible last. Reversing steps 2 and 4 — subtracting the deductible before capping at the limit — is the most common arithmetic error on exam payment questions, so always cap first and net the deductible at the end.