What Is an Excess on an Insurance Policy?

An insurance excess represents a predetermined amount a policyholder agrees to pay out-of-pocket towards an approved claim before the insurer contributes. This amount is clearly stated within the insurance policy documentation. This mechanism helps to distribute the financial responsibility for a claim between the policyholder and the insurance provider.

Understanding Insurance Excess

Insurance excess serves several purposes. It acts as a disincentive for policyholders to file numerous small claims, which helps reduce administrative costs for insurers. It also encourages policyholders to exercise greater care with their insured assets, as they bear some initial financial responsibility for any damage or loss. By sharing a portion of the risk, the excess mechanism can contribute to keeping overall insurance premiums more affordable for policyholders.

While the terms “excess” and “deductible” are often used interchangeably, particularly in the United States, where “deductible” is more prevalent, they serve a similar function. Both require the policyholder to pay a specific amount before the insurance coverage begins to apply to a claim. Regardless of the terminology, the policyholder is responsible for a specified amount of the loss.

How Excess Works in Claims

When a policyholder files a claim, the excess amount is applied directly to the total approved cost of the loss. The pre-agreed excess amount is then subtracted from this total approved payout. The insurer subsequently pays the remaining balance to the policyholder or directly to the service provider, such as a repair shop.

For example, consider a car insurance policy with an excess of $500. If the insured vehicle sustains damage costing $3,000, the policyholder would be responsible for paying the initial $500. The insurance company would then cover the remaining $2,500 of the repair cost. If the total repair cost for a covered event is less than the excess amount, the policyholder would pay the entire cost, and the insurer would not make a payout.

Types of Excess

Insurance policies can incorporate different types of excess. A common type is compulsory excess, which is a fixed amount determined solely by the insurer and cannot be negotiated by the policyholder. This amount may vary based on factors such as the policyholder’s age, driving experience, or the nature of the insured item.

Another type is voluntary excess, which is an additional amount the policyholder chooses to pay on top of any compulsory excess. Electing a higher voluntary excess can lead to a reduction in the annual insurance premium, as the policyholder agrees to bear a greater portion of the financial risk in the event of a claim. The total out-of-pocket cost for a claim would then be the sum of both the compulsory and voluntary excess amounts. Excess can also be structured as a fixed monetary amount or a percentage of the claim value, with percentage-based excess often applied in scenarios involving higher potential losses, such as natural disaster coverage.

Selecting Your Excess Amount

Choosing the appropriate excess amount for an insurance policy involves balancing potential upfront savings with future financial obligations. Generally, a higher excess amount will result in lower annual insurance premiums, while a lower excess will lead to higher premiums. This trade-off requires policyholders to consider their personal financial situation and their ability to pay the excess if a claim arises. It is advisable to select an excess amount that could be comfortably paid from available savings without causing financial strain.

An individual’s risk tolerance also plays a role in this decision. Policyholders who are comfortable with a higher out-of-pocket expense at the time of a claim, perhaps due to a lower likelihood of filing claims, might opt for a higher excess to benefit from reduced premiums. Conversely, those who prefer greater predictability and lower immediate costs during a claim event may choose a lower excess, accepting a higher premium. Evaluating the frequency of potential claims and having an emergency fund to cover the chosen excess amount are practical steps in making an informed decision.