To Increase or Not to Increase Your Deductible? How to Optimize Your Company’s Insurance Purchase
Posted in: Commercial Insurance
I often see, especially during annual policy renewals, clients struggling with making a decision whether to increase their insurance deductible. This is a common dilemma that companies of all sizes across all industries face. In this post, I discuss an example, which can help you evaluate whether increasing your deductible would translate to cost savings for your company.
When multiple deductible options are available, how do you decide which option is the best deal?
The good news: there is a way to figure this out. The bad news: it involves a combination of math and self-reflection on corporate priorities and philosophies.
For simplicity, let’s analyze deductible options with the limits being equal. Let’s say you are considering whether you should renew coverage with your current $50,000 deductible or opt for a higher $100,000 deductible. This analysis could be applied to any type of insurance deductible dilemma.
First, request your company’s five year currently valued loss run for the line of coverage in question. Secondly, look at the loss run for both frequency (the number of claims that occurred per year) and severity (how much was paid out on each claim). Let’s say your claims and premiums paid are as follows:
|Policy Year||Claim #1||Claim #2||Claim #3||Total by Year|
Total of all claims for 5 years: $631,000
Total paid by your company in deductible costs (up to the first $50,000 of each claim): $345,000
Total paid by the insurer (amounts above $50,000 per claim): $286,000
During the renewal process the following options are proposed to you:
|$50,000 Deductible||$150,000 Premium|
|$100,000 Deductible||$115,000 Premium|
Which choice is better? It’s difficult to know without running the numbers.
Option A: $50,000 deductible
|Average annual deductible cost ($345,000/5 years)||$69,000|
|Total annual cost||$219,000|
Option B: $100,000 deductible
|Average annual deductible cost ($466,000/5 years)||$93,200|
|Total annual cost||$208,200|
Assuming past experience is an indicator of future outcomes, we can see that the total expected annual cost of your risk with a $50,000 deductible would be $219,000.
However, if the deductible is increased to $100,000, your total expected annual cost of risk would be $208,200.
Therefore, based on the past experience, you would save $10,800 in the average year by electing the higher deductible option B.
So, the answer is option B, right?
It depends. We can see in the average year you would expect savings, but what about the worst case year that you experienced out of the last five, the 2012 year? Under the $50,000 deductible the deductible cost for that year was $150,000 ($50,000 for each of the 3 claims) while under a $100,000 deductible option the deductible costs would have been $245,000 ($95,000 more). Therefore, there is greater volatility in total cost to the firm from year to year with the higher deductible, but a savings on average.
Can your firm absorb this additional risk and volatility in exchange for realizing savings over the long term? If so, then option B is a logical choice.
If you need assistance calculating your options and considering your company’s objectives, contact me at email@example.com. Our teams of insurance professionals will also negotiate with various carriers to secure the best deductible and premium for your particular needs.