When you write out the check for your 6-month car insurance premium, do you ever get the sinking feeling that once again you’re paying out a chunk of change you’ll never get back?
If you’re a safe driver with a clean record, you may be thinking about raising your auto policy’s liability insurance deductible. Everyone knows the way to save money on car insurance premiums is to set the deductibles as high as humanly possible, right? But is the lower premium really worth the increased risk? Let’s take a look.
Why a higher deductible lowers your premium
The deductible is the amount you’ll pay on an insurance claim before the insurance company starts paying. You might think that a high deductible lowers your insurance premium because the insurance company’s costs are reduced by the amount of the deductible. Actually, having a high deductible on your insurance means that you’ll tend to file fewer claims, which means you’re a lower risk to the insurance company, and can therefore be charged lower rates.
Not having an insurance claim in the first place is far more profitable for insurance companies. Insurance companies survive based on how well they predict consumer behavior, and higher deductibles directly affect that behavior.
When a lower premium costs you more
How can you tell if the money you save by reducing your premium is worth the risk of the higher deductible? For example, let’s say that you reduced your six-month car insurance premium from $600 to $500 by increasing your deductible from $250 to $500. So in this example, you’d save $200 per year in premiums, but you risk paying an additional $250 out of pocket if you file a claim.
If you felt you could go claim-free for the better part of a year, you could partially “self insure” by stashing that $200 in your savings account. If you had to file a claim, you’d lose that $200 plus an extra $50, but you might come out $200 ahead. In the end, this boils down to a cost-benefit analysis.
If you’re risk-averse, you may have your deductible set as low as $250 to limit your out-of-pocket costs in an at-fault accident. I’ve had my deductible at $500 for a while now, but figured it wouldn’t hurt to call my car insurance company to find out just how much I could save if I raised my car insurance deductible even higher.
When I called my insurance company asking about raising my deductible from $500 to $1, 000, I was told that the savings I would earn on my premiums would only be $27 every six months. At that rate, I would have to be claim-free for about ten years in order to recoup the increase in risk I took by raising my deductible.
Is that a risk I want to take? Personally I’d rather pay the extra $27 for the piece of mind of not having to fork over another $500 out of my emergency fund in the next 10 years. In this case, the conventional wisdom of raising your car insurance deductible may not be the best course of action for your wallet.
Get lower premiums by reading the fine print
When was the last time you sat down and read your insurance policy? Not many people fully understand what their car insurance policy covers other than the basic limits they agreed to when they bought the policy. If you’re like many busy automobile owners, you may not have looked at the details of your policies for years.
When I was looking in-depth at my car insurance policy, I realized that I was not receiving credit for the GPS tracking system that was installed in my new car. If my car was ever stolen, the tracking system could help the police locate my car. Noticing this missing discount and asking for it ended up saving me $40 per year in premiums without accepting any new risks.
No matter where you set your car insurance deductible, you need to make sure that you have an adequate emergency fund in place. If you decide to raise your deductible, you need to be able to pay that extra money out of your emergency fund should you have an auto accident. Understanding how to conduct a simple cost-benefit analysis can help you to understand how to save on car insurance without dramatically increasing the risks that you take.
How’s your deductible?
What level of car insurance deductible do you favor – higher or lower? What’s your favorite way to save on car insurance?
About the Author: Hank Coleman is a personal finance writer and entrepreneur who has been writing about investing, retirement, and insurance for years. Hank holds a Bachelor’s Degree in Business Administration, a Master’s Degree in Finance, and is currently studying for his Certified Financial Planner (CFP) credentials.