What's the Point of Deductibles?

The use of deductibles is nearly universal in property insurance, and many lines of liability insurance utilize deductibles as well. Why are deductibles so commonly used? Are deductibles really saving the carrier that much money?

Paying a deductible is never a fun thing to do, and many people wonder if insurers are just being greedy by having deductibles on their policies. So is there are point to deductibles, or are insurers just slipping out on payments? Let's explore a few of the reasons why deductibles are actually the unsung heroes of insurance:

Fraud: An immoral person might be tempted to stage an auto accident or burn down their house for the insurance payout. However, the deductible cuts into their 'profit margin', reducing the instances of fraud. While deductibles don't stop everyone, it does reduce the chances of fraudulent claims being paid. Note: it's estimated that every American family pays an extra $550 a year simply to cover fraud.

Risk Compensation: It's been scientifically proven that when people have protection, they'll feel more comfortable doing riskier activities—such is the case for the implementation of seatbelts and the resulting increase in auto deaths. So while people are psychologically primed for riskier activity when they're insured, having a deductible tempers them by having some 'skin in the game'.

Morale Hazard: On a similar note, Morale Hazard is simply an indifference to losses caused by protection. Mentally, without a deductible, the loss is someone else's money, making it almost painless. For example, when someone buys the optional insurance on their rental car, they often proceed to curb-check, bump into things, and work the vehicle extra hard since it's not theirs and they don't have to pay for the damages. The deductible acts as an incentive to act in a safe, responsible manner. 

Operating Costs: Deductibles create a loss threshold, reducing operating costs for the carrier. Claims take a great amount of time and manpower to process, costing a lot of money. Can you imagine an insurance company having to pay a $12 claim for a broken stapler? It would cost the insurer ten or twenty times that to process and pay the claim! It's an expensive process, so the carriers save time and money by leaving the smaller, more mundane claims to the policyholders. This shift of responsibility materializes as the deductible, and it also allows the carriers to be more responsive to the claims that pass the deductible threshold. Moreover, having to pay and process every claim, starting at the first penny, would make insurance too expensive for anyone to reasonably purchase!

Deductibles are one of the most important features of insurance, much to our dismay, and moreover, deductibles allow us to have coverage in the first place. They force us to feel a bit of the pain in a loss, and they incentivize us to only use our insurance as it was intended: for unforeseeable, unpreventable claims. All of this culminates to create a less-expensive, more-efficient insurance product, which benefits everyone.