If you’ve been looking at various insurance plans and comparing premium costs for healthcare coverage or insurance for your cars and vehicles, you’ve probably run across the term deductible. But, what is a deductible, and how does it affect your insurance cost?
Let's take a look at how deductibles work for a healthcare insurance plan and insurance for your cars and vehicles.
What Is a Deductible?
A deductible is the amount you have to pay for services before your insurance plan begins to pay. For example, if you use health care services that total $500, or if you have a claim for vehicle damages covered by your automobile policy, and you have a $1,000 deductible, you must pay 100 percent of the $500 yourself.
Your insurance company would only begin to pay for a claim once the amount exceeds the deductible.
How Does a Health Insurance Plan Deductible Work?
Health insurance plans have one deductible amount to meet for the year. After meeting that deductible amount, you’ll make co-pays and share expenses, known as coinsurance, with your insurer.
Co-pays are the amount you must pay out of pocket for various medical services, such as visiting your doctor. Or a co-pay could be the amount you have to pay whenever you get refills for prescription drugs.
Coinsurance is the amount that you have to pay out of pocket for covered medical costs after meeting your deductible. For example, if your insurance plan requires you to pay 20 percent coinsurance, you will pay 20 percent out of pocket for medical bills, and your insurance plan will cover the remaining 80 percent.
Health insurance plans have a maximum limit on the out-of-pocket costs you are required to bear. The maximum out-of-pocket amount is the most money you would have to spend in a year on your deductibles, co-pays and coinsurance. Once you have reached your out-of-pocket maximum, your insurance plan would cover 100 percent of all medical expenses thereafter.
For example, suppose you have an insurance plan with a $1,000 annual deductible, 20 percent coinsurance and a maximum out-of-pocket cost of $7,000, and you need surgery that will cost $125,000. You’ll pay the first $1,000 to the hospital to meet your deductible. After that, your coinsurance will pick up 80 percent of the covered medical expenses, and you’ll pay 20 percent. You’ll have to pay the remaining $6,000 ($7,000 maximum less $1,000 deductible) until you reach the maximum out-of-pocket expenses of $7,000. After reaching that limit, your insurance plan will cover 100 percent of the remaining medical and hospital expenses from the surgery and any other medical expenses you have for the rest of the year.
Health care plans usually cover 100 percent of the costs for certain preventive care services without any deductibles.
Deductibles for insurance policies can be confusing and making the best choice requires an understanding of the financial consequences.
What Are High- and Low-Deductible Health Plans?
Healthcare insurance plans have traditionally had low deductibles. However, in an effort to reduce premium costs and meet demands from consumers, insurance providers have begun to offer high-deductible plans, also known as HDHPs.
HDHPs have much lower monthly premiums than traditional insurance plans and are best suited for healthy people who don’t expect to incur any major medical expenses in the near future. The downside is that you will have to pay 100 percent out of pocket for your medical costs until you meet the higher deductible amount.
One way to lessen the financial risks that comes with high-deductible insurance plans is to set up a health savings account (HSA). With an HSA, you can contribute pre-tax dollars into a special account that can be used for qualified medical expenses in the event of an emergency or unexpected medical event. If the funds aren't used, they can be carried over to the next year.
High-deductible plans are best for people who are young and healthy, don't make many visits to the doctor, aren't taking prescription drugs, don’t have dependents and have the financial resources to cover the higher out-of-pocket costs in case of unexpected medical problems.
Low deductible insurance plans have the benefit of minimizing out-of-pocket costs on medical expenses. These plans work best for people who make regular visits to the doctor or have a large family with more medical issues or pre-existing conditions. Under these conditions, it's easier to plan and control your budget for medical expenses.
Even though the premiums for low-deductible plans are higher, they are best used for people over age 65, families whose members require continuous and regular medical care and may expect major upcoming medical expenses or have a history of various illnesses.
How Does an Auto Insurance Deductible Work?
Unlike healthcare insurance plans, insurance policies for autos have deductibles for each event rather than for an entire year.
For example, if your windshield is broken, and you have a $500 deductible for comprehensive coverage, you would have to pay the first $500 of the expense to replace the windshield. If you are later involved in an accident where the expenses are covered by your insurance plan, you would have to pay another $500 for repair expenses because the $500 deductible would apply again.
Most automobile insurance policies have separate deductibles for comprehensive and collision coverage. However, depending on your state’s laws, you could also have a deductible on uninsured motorist property damage and personal injury coverage.
How Do Deductibles Affect Your Personal Finances?
Generally, plans with lower deductibles have higher premiums and, conversely, insurance policies with higher deductibles have lower premiums. This means that you can reduce your insurance premiums by raising the deductible, but this also means that you will increase your financial risk. The decision to increase your deductible should be based on your ability to cover the higher dollar amount of the deductible.
For example, suppose you currently have a $250 deductible, and you decide to raise the deductible to $1,000. You must be prepared to come up with the additional $750 to cover the additional amount if you have a claim that exceeds $1,000. If you don't have the extra amount of money available in your cash reserve or savings account and coming up with the additional cash could put a strain on your finances, increasing your deductible to get a lower monthly premium might not be a good idea.
Other Insurance With Deductibles
Health and automobile insurance aren't the only policies that have deductibles. These are the other types of insurance that you may have with deductibles.
Homeowners insurance - Claims under homeowners insurance are usually for higher amounts, so opting for lower deductibles is typically a better strategy.
Boat, motorcycle and RVs - These policies will have deductibles for each event that occurs under comprehensive and collision.
Pet insurance - Deductibles for your pets usually have an annual deductible, similar to health insurance.
Home warranties - These policies have deductibles for each claim.
James Woodruff has been a management consultant to more than 1,000 small businesses. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company's operational, financial and business management issues. James has been writing business and finance related topics for work.chron, bizfluent.com, smallbusiness.chron.com and e-commerce websites since 2007. He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University.