Car Insurance: Choosing cost-effective deductibles

From Insurance for Dummies by Jack Hungelmann

I estimate that the average client has a claim for damage to their vehicle every four or five years. I therefore advise clients to choose a higher deductible if the extra risk (the difference in deductibles) can be recouped via premium savings within a reasonable time (in other words, four to five years). The number of years it takes to recoup that added risk is called the payback period. The formula looks like this:

Payback period = the difference in deductibles ÷ the difference in annual premiums

If you’re trying to figure out the most economical deductible, look at the hypothetical examples to better understand how to determine the best deductible for you.

A Three-Year-Old Lexus Coupe, Driven by a 47-Year-Old Female for Business 

	Collision	Comprehensive
Deductible	$250/$500/$1,000	$100/$250/$500
Extra Risk (difference)	$250/$500	$150/$250
Annual Premiums	$500/$400/$300	$250/$200/$150
Annual Savings	$100/$100	$50/$50
Payback Period (extra risk/savings)	2.5 years/5 years	3 years/5 years

 Here’s an example of how to use a table:

The table above is an example of insurance costs for Collision and Comprehensive coverage for a three-year-old Lexus driven by a 47-year-old female and used for business. Reading across from left to right, the first row, Deductible, shows the different deductible choices for both damage coverages. The second row, Extra risk, shows the dollar amount of difference between each deductible (the extra dollar amount you will be at risk for if you choose a higher deductible). The third row, Annual premiums, shows the annual insurance cost for each deductible. The fourth row, Annual savings, shows the annual insurance cost savings if you choose the next higher deductible. And the fifth row, Payback period, represents the number of years it would take without a claim to save, through your reduced premiums, the amount of extra risk you would assume by opting for higher deductibles. The payback period is determined by dividing the extra deductible risk in row two by the annual insurance premium savings in row four. If the payback period is less than four or five years, choosing the higher deductible makes good sense.
 
In the above table, the extra risk, from the second row, to increase your Collision coverage deductible from $250 to $500 is $250. The annual premium savings, from row four, to make that change is $100. Dividing the $250 extra risk by the $100 annual savings gives you 2.5 years. That means if you go 2.5 years without any claims, you save $250 on your insurance costs — the amount of the added risk you took by raising your deductible. Using the rule of choosing a higher deductible if the payback period is less than four or five years, it’s clear that raising the deductible makes sense.
The payback period from the example in the next table — even for the highest deductibles — is only five years for Collision and Comprehensive coverages, making it logical to take the added risk for both coverages.

A Five-Year-Old Honda Accord, Driven by a 35-Year-Old Male, 10 Miles Each Way to Work 

	Collision	Comprehensive
Deductible	$250/$500/$1,000	$100/$250/$500
Extra Risk (difference)	$250/$500	$150/$250
Annual Premiums	$300/$200/$100	$150/$100/$50
Annual Savings	$100/$100	$50/$50
Payback Period (extra risk/savings)	2.5 years/5 years	3 years/5 years

The next table shows a five-year-old Honda used to commute to work by a 35-yearold male. Although the premiums are less than they are for the more expensive Lexus, the extra risk of the higher deductibles can still be recaptured in five years and is still worth taking.

A Twelve-Year-Old Chevy Cavalier, Driven by a 19-Year-Old Male, with Three Speeding Tickets 

	Collision	Comprehensive
Deductible	$250/$500/$1,000	$100/$250/$500
Extra Risk (difference)	$250/$500	$150/$250
Annual Premiums	$1,200/$1,000/$800	$600/$450/$300
Annual Savings	$200/$200	$150/$150
Payback Period (extra risk/savings)	1.3 years/2.5 years	1 years/1.7 years

The table above shows an older Chevy driven by a 19-year-old with three recent speeding tickets whose rates are much higher due to both his age and his driving record.
Clearly, with payback periods of 2.5 years or less for each deductible, this high-risk driver is better off with the highest deductibles possible. Not to mention that, with three tickets, he won’t be turning in small claims anyway as they may result in his being dropped by the insurance company. Would he be better off not carrying the coverages at all? See the section “Knowing when to drop Collision and Comprehensive coverage” for tips on making that call.  

The Same Twelve-Year-Old Chevy Cavalier, Driven by a 74-Year-Old, with a Clear Record 
 

	Collision	Comprehensive
Deductible	$250/$500/$1,000	$100/$250/$500
Extra Risk (difference)	$250/$500	$150/$250
Annual Premiums	$150/$100/$50	$75/$50/$30
Annual Savings	$50/$50	$25/$20
Payback Period (extra risk/savings)	5 years/10 years	6 years/12.5 years

In the table, check out what happens to the insurance costs for this same Chevy if the 19-year-old sells the car to his 74-year-old granny who has never had a ticket in her life. The payback period for the highest deductibles far exceeds the four to five year guideline. This driver would clearly be better off with low to midrange deductibles.

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Posted 7 Dec 2009 6:52 AM