When you take out insurance coverage, you share some risk with your insurance company by agreeing to pay part of the claim costs through a deductible. Typically, companies offer a standard or recommended deductible, but will allow you to change the amount. A change will have a direct effect on the premium cost.
The premium is what you pay to buy and keep the coverage. The deductible is what you pay if you file a claim before your insurance company starts to pick up the tab. For example, if you have a $500 deductible on your auto insurance and need $1,500 of repairs, you pay $500,and your insurer pays the remaining $1,000. Deductibles are typically a dollar amount but, in some policies such as homeowners insurance, they may be set as a percentage.
Risk, Premiums and Deductibles
Insurance companies base their premium costs on how much of a risk you are to ever file a claim. If you're a low risk, you typically get a lower premium; if you're a high risk, you're likely to pay more. The deductible is also a factor in the pricing process. The insurance company has to pay more for claims with low deductibles. If you raise a deductible, the company may reward you for decreasing its potential costs by giving you lower premiums.
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The Effects of Changing Deductibles
If you take a low deductible, you must budget for high premium costs very month. However, you'll pay less out-of-pocket for any claim you file. If you raise the deductible, and your premium costs go down, you'll have lower monthly payments but more cost liability in a claim. Raising a deductible may give you significant savings. According to the Insurance Information Institute, raising the deductible on homeowner's insurance from the average of $500 to $1,000 could reduce your premiums by up to 25 percent.
Compare premium costs before and after a deductible increase -- if you only save a few dollars, it may not be worth raising it. You should also avoid taking a deductible that you can't afford just to save more on premiums. Not all deductibles remain the same, so you may need to look beyond immediate savings. For example, if your homeowner's insurance coverage is a percentage of the value of your home, the amount you might have to pay will go up as your home increases in value.