Commercial Property Insurance Deductibles
A Deductible Is a Type of Self-Insurance
Deductibles serve several purposes. One is to ensure that coverage remains affordable. Small claims are costly to adjust. If deductibles did not exist and insurers had to pay every small property loss, the cost of insurance would likely increase.
The availability of deductibles gives policyholders some choice in how they utilize their premium dollars. A deductible is a type of self-insurance. A policyholder that accepts some risk in the form of a higher deductible will pay a lower premium. The policyholder can then invest the savings in the business.
Finally, deductibles encourage policyholders to practice good risk management. Policyholders will be motivated to protect their property against damage if they know they will have to pay a portion of each loss.
Most Common Deductibles
There are three types of deductibles that commonly appear in commercial property policies: flat deductibles, percentage deductibles, and waiting periods.
Most commercial property policies include a flat (or straight) deductible. A flat deductible is a specified dollar amount that applies to each loss. It is subtracted from the amount of a covered loss. The amount remaining is paid by the insurer.
For example, suppose that your policy includes a $2,500 deductible and a $250,000 limit. Your property incurs a $50,000 fire loss. If no coinsurance applies your insurer will pay $47,500 ($50,000 - $2,500). If the loss is subject to coinsurance, your insurer will determine whether your limit is adequate. If it isn't, the insurer will reduce your insured loss by the coinsurance penalty. The insurer will then pay the difference between the adjusted loss amount and your $2,500 deductible.
A flat deductible applies to each occurrence. If more than one occurrence takes place during the policy period, the deductible applies separately to each. For instance, suppose an insured building is damaged by vandals in September and by a fire in October. The vandalism and the fire were two separate occurrences so each is subject to the deductible.
Most commercial property policies include a flat (or straight) deductible. A flat deductible is a specified dollar amount that applies to each loss.
A percentage deductible often applies to perils that can cause catastrophic losses. An example is earthquake. When earthquake is a covered peril and a loss occurs, the loss is typically reduced by a deductible that applies on a percentage basis. The deductible may be a percentage of the limit or the value of the damaged property.
For example, suppose that a building is insured under a Difference in Conditions policy that covers earthquake. The earthquake limit is $500,000 and the deductible is 15% of the building limit. If the building sustains $250,000 in earthquake damage, the insurer will pay $175,000 ($250,000 - $75,000) and the policyholder will pay the $75,000 deductible.
Losses caused by hurricanes, other windstorms or hail may also be subject to a percentage deductible. Hurricane deductibles are common in states along the Atlantic and Gulf Coasts. They apply to damage caused by hurricanes only, not other types of windstorms. The meaning of hurricane may be determined by the policy wording or by state law. Generally, a windstorm is considered a hurricane only if is declared as such by National Weather Service. A hurricane deductible is typically expressed as a percentage of the insured value of the building.
Property policies issued in some states may include a wind or wind/hail deductible. A wind deductible applies to damage caused by any type of wind (hurricane, tornado, straight winds, etc.). A wind/hail deductible applies to damage caused by wind or hailstones. A wind or wind/hail deductible is typically a percentage of the value of the insured building.
Most business income policy forms don't use the word "deductible." Nevertheless, they may include a type of deductible called a waiting period. A waiting period is the amount of time that must elapse before coverage begins. A typical business income waiting period is 72 hours (3 days). Income you lose during the waiting period is not covered.
Other Types of Deductibles
Two other types of deductibles that appear in some property policies are aggregate deductibles and franchise deductibles. An aggregate deductible represents the most a policyholder will pay out of pocket within a specified time period (typically the policy year). For example, suppose a property policy includes a $10,000 aggregate deductible. The insured sustains three losses during the policy period. The first two losses ($4,000 and $6,000) fall within the deductible so the insured business pays them itself.
The insurer pays the third loss (for $5,000) in full. By the time that loss occurs, the policyholder has satisfied its aggregate deductible obligation.
A franchise deductible represents the minimum loss that must occur before insurance will apply. For example, suppose a policy contains $5,000 franchise deductible. No coverage will apply if the insured sustains a $4,000 loss because the franchise has not been reached. However, a $5,000 loss will be covered in full because the franchise has been satisfied. Franchise deductibles are often used in marine insurance, including ocean cargo coverage.