Deductibles Explaination
This Bulletin is designed to give guidance on the technical implications of the various forms of deductible commonly in use in the market. Care should always be taken that all three parties, the client, the insurer and ourselves are totally agreed as to how any deductible is to be applied.
A deductible is a monetary, or sometimes a time element, amount that is regarded as being self insured by the client.
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Deductibles Explaination
This Bulletin is designed to give guidance on the technical implications of the various forms of
deductible commonly in use in the market. Care should always be taken that all three parties, the
client, the insurer and ourselves are totally agreed as to how any deductible is to be applied.
A deductible is a monetary, or sometimes a time element, amount that is regarded as being self
insured by the client.
Franchise, Excess , Deductible and Self Insured Retention (SIR)
A franchise is a monetary or time element amount that is retained by the insured unless the loss
exceeds the stated limit, when the loss will be paid in full.
An excess is normally a monetary amount totally self-insured by the insured. The simplest
example of a traditional “excess,” under a Motor Policy, for example, is where the insured pays
the first $200, say, of any one loss for own damage claims.
Deductible is an American expression, literally meaning a self-insured deduction from the loss. In
casualty classes the policy limit is normally reduced by the amount of the deductible. In property
classes loss limits are more commonly paid in excess of the deductible.
Self Insured Retention (SIR) is a phrase used for larger clients, often with a multi-class programme,
where policy limits for both casualty and property are paid in excess of the SIR.
Effect of a deductible in layered risks
As mentioned above, the application of a deductible amount is often distinctly different as
between Property and Casualty risks.
Liability risks are often “layered,” the attachment point of succeeding layers being determined
by the underlying maximum limit. The operation of a deductible only affects the first layer and
the insurer concerned will pay up to the maximum limit of liability of the primary layer, less the
amount of the deductible to avoid any shift in succeeding layer attachment points.
Property risks, conversely, are often written on a total insured value or first loss basis. Underwriters
normally pay a loss in excess of the deductible up to the full policy limit. The effect of this is that the
limit is actually in addition to the deductible, rather than the deductible forming part of the limit. If, as
is becoming more frequent in a hardening market, property risks are also layered then the
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“casualty” rules will need to apply to ensure the attachment points are not shifted.
Deductible each and every loss
This terminology is applied to slips or quotes and needs amendment to ensure that no more
than one deductible is applied to any one loss, or series of losses arising from one original
cause.
The words in bold italics are normally sufficient to address this issue but one word of caution. If we
use these words on a products liability policy the underwriters will apply the same principle to the
application of policy limits. In other words, if there were to be a whole series of losses arising from
a single insured event over a period of time then whilst only one deductible may be applied, the
limit might become exhausted. Further complications might arise if the losses spanned more than
one policy period. Underwriters usually address the question of potential “batch” losses
(particularly prevalent in the food or pharmaceutical industries) in their policy language, but this
sort of problem could arise in any industry supplying multiple products.
Combined Deductibles
This term is frequently encountered on Property and Business Interruption risks where the policy
may be subject to a combined deductible each and every loss. The effect of this is to deduct the
agreed amount from the total combined loss for both Property and Business Interruption. The
advantage to the client is that they have a known self- retention from any one incident and can
plan their funding accordingly.
Sometimes programmes for smaller clients are designed with a lower or nil deductible on items
such as Money risks or BI. The reason for this is that the economic effect of a deductible on money
risks (normally flat rated ) is negligible so there is no incentive for the client to take a deductible
unless one is imposed. For Business Interruption losses it is impossible to predict the total amount
of any claim, if any, before the whole costly process of adjusting the loss has been gone through. In
this respect, the discounts for BI deductibles are normally much less than for their PD counterparts.
Hence the reason for not taking a voluntary BI deductible on smaller risks, unless, again, it is
imposed as it would have limited economic effect on the premium levels.
Time Deductibles
A time deductible or franchise is often imposed on electrical or mechanical breakdown risks to
ensure that routine maintenance type losses lasting for, say, up to 48 hours, are not covered.
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On Utility Failure extensions to BI policies there is frequently a 30 minute time deductible or 24
hour franchise to cater for incidental power outages – this deductible would be higher in
overseas territories where there is less integrity in the local national grid system.
Time deductibles on other BI risks are to be discouraged as the potential monetary amount
represented by the period can often be out of all proportion to a client’s normal level of self-
retention. Aon’s practice is to recommend monetary deductibles wherever possible – unless a time
deductible is the only way in which cover can be obtained – as in oil and petrochemical risks, for
example.
Property risks will need further amendment to import a time element relative to a single event
such as a single Storm, Flood Earthquake or Riot “event” affecting several insured locations.
This will ensure that only one deductible is applied to the single event, rather than a separate
deductible for each location for the same event.
The period allowed is usually 72 hours, which can span policy periods if necessary, and the
clause is therefore frequently referred to as the “72 hour” clause.
Working or Residual Deductibles
For major risks the client will select a limit below which they would normally expect to deal with
losses in house and for which they have no expectation of insuring. The amount selected will vary
by size and type of business, but the intention is to totally exclude maintenance type losses from
the loss statistics.
The term “residual” deductible is also frequently applied to the self-retention insurers expect the
client to retain should an aggregate deductible be breached.
Aggregate deductible
Underwriters recognise that clients have a limited capacity for self-retention so are able to offer a
price to limit the client’s total retention of deductibles for losses any one year to a specified
amount. The Aggregate can be for a single class, or tower, of business, such as Public/Products
liability or could be combined across several classes, or towers such as Property, BI, PL/Prods, PI,
E.L. and Motor.
Normally the residual or working deductibles do not contribute towards the erosion of the aggregate
limit, and are termed “non-ranking.”
The funding of the Aggregate is the most common reason for client’s wishing to form Captive
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Insurance Companies, particularly where smaller subsidiaries are unable to withstand the full
effect of the deductibles imposed and need to “buy down” the deductible to a more acceptable
level to their operation.
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