What is the purpose of an insurance policy's deductible?

The purpose of a deductible within an insurance policy is to define the specific amount that the insured must pay out of pocket before the insurance coverage begins to respond to a claim. For example, if a policy has a deductible of $500 and the insured incurs a loss of $2,000, the insured would be responsible for paying the first $500, with the insurance company covering the remaining $1,500.

This structure serves multiple functions. It not only encourages the insured to share a portion of the loss but also helps to reduce the overall cost of premiums. Insurance companies typically lower premiums for policies that have higher deductibles because they expect that the insured will absorb some of their own losses. This risk-sharing aspect can lead to more responsible behavior from policyholders in regard to minimizing claims for minor damages.

In contrast, while the deductible might impact the insurer's profitability and the premium payments the insured makes, its primary role is to establish the threshold before the policyholder can access insurance benefits. It does not inherently limit the total payout under any circumstance; rather, it is a defined cost-sharing mechanism between the insurer and the insured at the time of a claim.