What is excess in insurance and why is it used?

Insurance provides financial protection against unforeseen events. A fundamental component of many insurance policies, often termed “excess” or “deductible” in the United States, influences both the upfront cost of insurance and out-of-pocket expenses during a claim. Understanding this concept is essential for policyholders to grasp their financial responsibilities and the mechanics of their coverage.

Understanding Insurance Excess

Insurance excess is the predetermined amount a policyholder pays towards an insured loss before the insurance company contributes. This sum is clearly stated in the insurance policy documents and represents the initial portion of the claim the policyholder must cover.

The inclusion of an excess serves several purposes for insurers. It helps keep insurance premiums more affordable by sharing the risk between the insurer and the policyholder. By requiring policyholders to bear a portion of the cost, insurers can reduce their overall payout liability, especially for smaller claims.

The excess also encourages policyholders to act more responsibly and take greater care of their insured property. It discourages the submission of numerous small, frequent claims, which are administratively costly to process. This ensures insurance primarily covers more substantial losses, aligning the interests of both the insurer and the insured.

Applying Excess in Claims

When a claim is made, the excess amount is factored into the payout process. The policyholder typically pays this amount first, either directly to the repairer or to the insurer. The insurance company then covers the remaining costs up to the policy’s specified limit. For instance, if a car repair totals $4,200 with a $500 excess, the policyholder pays $500, and the insurer pays $3,700.

The excess generally applies per incident or per claim, rather than per policy period. If multiple separate events lead to claims within the same policy term, an excess is payable for each individual incident. For example, damage from a storm followed by a separate incident like theft would typically require an excess payment for each claim.

If the cost of the damage or loss is less than the excess amount, the policyholder is responsible for the entire cost, and the insurer pays nothing. Policyholders should evaluate whether making a claim is beneficial when repair costs are close to or below their excess.

Variations of Excess and Premium Effects

Insurance policies feature different types of excess, each with specific implications for policyholders. A “compulsory excess” is an amount set by the insurer that cannot be altered by the policyholder and is a mandatory part of the policy. This amount can vary based on factors like the type of coverage, the insured item, or the policyholder’s risk profile.

Many policies also offer a “voluntary excess,” an additional amount the policyholder can choose to pay on top of the compulsory excess. Other common variations include age-based or inexperienced driver excesses, which apply a higher amount due to increased risk. Some policies may also have specific excesses for certain perils, such as different amounts for fire damage versus water damage.

The amount of excess chosen has a direct relationship with the insurance premium. Opting for a higher voluntary excess typically results in a lower premium. Conversely, selecting a lower excess usually leads to a higher premium. This creates a trade-off where policyholders can balance immediate savings on premiums against potential out-of-pocket costs at the time of a claim.