Deductible

How deductibles work

In a typical insurance policy, when a covered loss occurs, the policyholder pays the deductible first, and the insurer pays anything above that up to policy limits.

Concrete example: an auto policy with a $1,000 deductible. Your car gets damaged in a covered accident with $5,000 in repairs. You pay $1,000; the insurer pays $4,000.

If the damage is below the deductible (say $700), the insurer pays nothing. You absorb the full cost. This is why filing small claims often makes no sense — the deductible is more than the loss.

The trade-off with premiums

Higher deductibles mean lower premiums and vice versa. The math:

• Lower deductible → insurer takes on more of every claim → higher premium.
• Higher deductible → insurer takes on less per claim, fewer small claims filed → lower premium.

For most people, a moderately high deductible is the right choice. Low deductibles ($250 vs. $1,000 on auto insurance, for instance) can cost hundreds per year in extra premium for what amounts to insurance against $750 of difference. Self-insuring that gap typically pays off over time, especially for people with emergency funds.

Health insurance deductibles

Health insurance deductibles work similarly but with several layers:

• Annual deductible — the amount you pay before the insurer starts paying. Resets each plan year.
• Coinsurance — after meeting the deductible, you pay a percentage (often 20%) of further costs until reaching the out-of-pocket maximum.
• Out-of-pocket maximum — the most you'll pay in a year. Above this, the insurer pays everything covered.
• Copays — flat dollar amounts for specific services (e.g., $30 for a doctor visit), often applied even before the deductible is met.

Health plans range from low-deductible PPOs ($250-$500 annual deductible, higher premiums) to high-deductible health plans (HDHPs, $1,500+ deductibles, lower premiums). HDHPs pair with HSAs and offer significant tax advantages for healthy individuals.

Why insurance has deductibles at all

Two structural reasons:

• Reduce moral hazard. If insurance covered everything from dollar one, people would file claims for tiny losses, driving up administrative costs and overall premiums. The deductible aligns incentives.
• Reduce administrative cost. Processing a $200 claim costs the insurer money. Deductibles eliminate small claims entirely, lowering the cost structure.

The same dynamic appears in DeFi insurance protocols (Nexus Mutual, Sherlock) where coverage typically has a similar threshold-based structure.

Choosing a deductible

A good rule of thumb: pick a deductible you could comfortably pay without financial strain. If $1,500 in unexpected expenses would derail your finances, a $1,500 deductible is too high.

For most people:

• Auto insurance — $500-$1,000 is the typical sweet spot.
• Homeowner's insurance — $1,000-$2,500 typically. Hurricane and earthquake riders may have separate (higher) deductibles.
• Health insurance — depends heavily on expected utilization. Healthy individuals often save with HDHPs; those with regular healthcare needs may save with lower deductibles.

The math should account for expected claim frequency, not just per-claim cost. A driver with multiple claims per year benefits from a lower deductible; a driver who hasn't filed in a decade is paying for nothing with one.

"Deductible" in tax language

The same word appears with a different meaning in tax contexts. A "tax deduction" reduces your taxable income, lowering tax owed. The mortgage-interest deduction, for instance, lets you subtract qualifying home-loan interest from income before calculating tax.

That's tax deduction — distinct from an insurance deductible despite the shared word. Both mean "amount you bear yourself" in their respective contexts, but the financial mechanics are different.