2.4 Deductibles, Limits, and Loss Settlement
Key Takeaways
- A deductible is the insured's retained portion of each loss; flat deductibles are a fixed dollar amount while percentage deductibles (wind/hurricane, earthquake) are a percentage of the dwelling limit.
- Limits cap the insurer's payment: per-occurrence limits apply to each event while aggregate limits cap total payments for the policy period.
- Sublimits restrict recovery on specific property such as money, jewelry, or firearms below the overall Coverage C limit.
- Other-insurance clauses (pro rata, primary/excess, contribution by equal shares) decide how multiple policies share a loss.
- Loss settlement follows the valuation basis and then applies coinsurance, the sublimit, the deductible, and finally the policy limit.
Deductibles: the Insured's Retained Layer
A deductible is the portion of every loss the insured keeps before the insurer pays. Deductibles lower premium, discourage small nuisance claims, and reduce morale hazard by giving the insured a financial stake in preventing loss.
| Deductible type | How it works | Where it appears |
|---|---|---|
| Flat (straight) deductible | Fixed dollar amount subtracted from each loss | Most homeowners and commercial property |
| Percentage deductible | A percentage of the dwelling or building limit | Wind/hurricane and earthquake coverage |
| Franchise deductible | Insurer pays nothing below a threshold, then pays in full | Marine and some specialty lines |
| Waiting period | A time deductible before payment begins | Business income and time-element coverage |
A percentage deductible can be large. On a $400,000 home, a 5% hurricane deductible is $20,000, far more than a typical $1,000 flat deductible, and earthquake deductibles of 10-20% are larger still.
Limits: Per-Occurrence, Aggregate, and Sublimits
A limit is the most the insurer will pay. The exam distinguishes several kinds.
- Per-occurrence limit: the maximum for any single event. A windstorm that damages roof and contents draws on one per-occurrence limit.
- Aggregate limit: the maximum for all losses during the policy period. Once exhausted, the policy pays no more even if new losses occur.
- Sublimit: a smaller cap on specific property inside a larger limit. Homeowners Coverage C carries sublimits, for example $200 on money, $1,500 on jewelry by theft, and $2,500 on business property on premises.
Split Limits Worked Example
Liability and some property coverages use split limits written as three numbers, such as $100,000 / $300,000 / $50,000: $100,000 per person, $300,000 per occurrence for bodily injury, and $50,000 per occurrence for property damage. If three claimants are each hurt $90,000 in one accident, the per-person cap pays $90,000 to the first, $90,000 to the second, and is then limited so the total does not exceed the $300,000 per-occurrence cap. A combined single limit (CSL) of $300,000 instead provides one flexible pool for both bodily injury and property damage.
Other-Insurance Clauses
When more than one policy covers the same loss, an other-insurance clause prevents the insured from collecting more than the loss and decides how the insurers share.
| Clause | How the loss is shared |
|---|---|
| Pro rata | Each insurer pays the share that its limit bears to total insurance |
| Contribution by equal shares | Insurers pay equally until the lowest limit is exhausted, then the rest share |
| Primary and excess | One policy pays first; the excess policy pays only after the primary limit is used up |
Pro rata example: Insurer A wrote $300,000 and Insurer B wrote $100,000 on a $40,000 loss. Total insurance is $400,000. Insurer A pays $300,000 / $400,000 x $40,000 = $30,000; Insurer B pays $100,000 / $400,000 x $40,000 = $10,000. The insured collects $40,000 once, never twice, because the principle of indemnity forbids profiting from a loss.
Loss Settlement: the Order of Operations
Settling a property loss follows a fixed sequence, and the exam loves to reorder the steps to create wrong answers. Work them in this order:
- Establish the loss amount under the policy's valuation basis (ACV or replacement cost).
- Apply coinsurance if the insured is underinsured, reducing the payable amount by the coinsurance ratio.
- Apply any sublimit for special categories such as jewelry or money.
- Subtract the deductible from the remaining figure.
- Cap at the policy limit so payment never exceeds the limit of insurance.
Under a replacement-cost policy, the insurer usually pays the ACV portion first and releases the recoverable depreciation after repairs are documented. Personal property is often settled at ACV unless a replacement-cost endorsement was purchased, which is a frequent distractor when a question gives a replacement-cost dwelling but ACV contents.
Special Limits and the Homeowners 80% Replacement-Cost Rule
Homeowners forms carry their own loss-settlement quirks layered on top of the general rules. To collect full replacement cost on the dwelling, the homeowner must insure to at least 80% of the full replacement cost at the time of loss. Insure below 80% and the form pays the larger of ACV or a proportion of the repair cost (the homeowners coinsurance-style penalty); insure to 80% or more and partial losses are paid at full replacement cost up to the limit.
| Coverage C sublimit (typical) | Limit |
|---|---|
| Money, bank notes, coins | $200 |
| Securities, deeds, manuscripts | $1,500 |
| Watercraft and trailers | $1,500 |
| Jewelry, watches, furs (theft) | $1,500 |
| Firearms (theft) | $2,500 |
| Silverware, goldware (theft) | $2,500 |
These sublimits are inside the Coverage C limit, not in addition to it, and they apply before the deductible. A client who needs more should schedule the item on a personal-articles floater, which provides higher limits, open-peril coverage, and often no deductible.
Aggregate Erosion and the Experience Modifier
Two additional limit concepts surface on the casualty side of property-casualty exams. First, an aggregate limit erodes as claims are paid: a general-liability policy with a $2,000,000 aggregate that has already paid $1,500,000 leaves only $500,000 for the rest of the term, even though the per-occurrence limit is unchanged. Tracking aggregate erosion is essential advice for active claimants.
Second, in workers compensation, an experience modification factor (mod) adjusts premium based on a business's loss history relative to peers. A mod of 1.0 is average; a mod of 0.85 means losses ran 15% better than expected and premium is reduced 15%, while a mod of 1.20 raises premium 20% for worse-than-average losses. If manual premium is $50,000 and the mod is 0.85, the modified premium is $50,000 x 0.85 = $42,500. The mod rewards safe employers and is a frequent numeric item, so practice multiplying manual premium by the factor.
A $500,000 home carries a 2% hurricane (percentage) deductible. A hurricane causes $40,000 of covered wind damage. How much does the insured retain through the deductible?
Insurer A wrote a $150,000 limit and Insurer B wrote a $50,000 limit on the same building under pro-rata other-insurance clauses. A $20,000 loss occurs. How much does Insurer B pay?