How Does a Deductible Work?

I know this sounds like a very simple question, but over the years I have asked this question in classes and there has been some uncertainty in the answers I have gotten. 

Let’s take a scenario.  We have a property insurance policy with a limit of insurance of $100,000 (it does not make any difference whether it is building or contests coverage) with a $1,000 deductible.  The property is a total loss by a covered cause of loss.  Does the insurer pay $100,000 or $99,000 to the insured?

A number of years ago I got a call from an agent who was trying to place $365,000 of property insurance with a $1,000 deductible.  The underwriter said that she could only write $364,000 in that case.  The agent was confused.  My response was she was incorrect: she could only write $363,000, no $362,000, etc. 

It appears that this underwriter believed that the deductible was subtracted from the limit of insurance.  (And this is one of the answers that I get when the question is asked in class.)  However, if you read the actual policy language in the deductible provision of most property insurance policies, it clearly states that the deductible will be applied to any covered loss or damage.  So, in the scenario above, the insured should receive the full $100,000 if the loss was at least $101,000. If the loss was $105,000, the insurer would subtract $1,000 from the amount of damage ($105,000 – $1,000 = $104,000) and pay the policy limit ($100,000) since the net loss exceeded the limit of insurance. 

If a co-insurance penalty was involved in the loss, then the insurer would subtract the deductible from the amount of loss adjusted by the co-insurance penalty and then apply the deductible.  An example would be instructive:

Value of the property:                   $100,000
Co-insurance:                                   80%
Amount of insurance:                    $60,000
Amount of loss:                               $10,000

Co-insurance formula:                    Amount of insurance (Did)                        
                                                            ————————   x Amount of loss
                                                            Value of prop x 80% (Should)

                                                                            $60,000
                                                                            ————   x $10,000
                                                                            $80,000

                                                                            75% x $10,000 = $7,500

                                                                            $7,500 – $1,000 = $6,500

So, deductibles apply to losses, not to limits.  I hope this resolves puzzled looks if the opening question is asked in a future class.                       

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