The Excess On Your Insurance Is Not A Punishment

You claim, and the first slice of the loss is yours. The figure is not a fee for making a claim, though it certainly feels like one at the time.

Small claims cost more to handle than to pay

Processing a claim involves validation, assessment, correspondence, payment and record-keeping, and that work costs broadly the same whatever the amount involved.

Below a certain value, the administration exceeds the payout, so covering small losses would raise everybody's premium by more than the losses themselves are worth.

The excess sets a threshold beneath which claims simply do not arrive, which keeps the cost of running the scheme in proportion to what it pays out.

It changes behaviour at the margin

Insurance that covered every loss completely would remove a small part of the incentive to be careful, an effect insurers describe as moral hazard.

The effect is subtle rather than dramatic. Almost nobody is careless because they are insured, but locking a door or securing a load is marginally less pressing when someone else pays.

Leaving the first portion with the policyholder keeps a stake in the outcome, and the presence of that stake is a large part of what the excess is for.

It sorts customers by risk

Offered a choice of excess levels, people tend to select according to what they know about their own circumstances, which the insurer cannot observe directly.

Someone expecting frequent small losses gravitates to a low excess and a high premium. Someone confident of few claims takes the opposite.

That self-sorting gives the insurer information it could not otherwise obtain, and lets it price two groups differently without needing to identify who is in which.

Premium and excess move together

Raising the excess lowers the expected payout and therefore the premium, while lowering the excess raises it. The relationship is arithmetic rather than promotional.

What that trade is worth to any individual depends entirely on their own circumstances and their capacity to absorb the first slice of a loss, which varies enormously.

Policies also differ in how the excess is structured, with compulsory and voluntary portions that add together, and terms that vary by jurisdiction and change over time.

Small claims carry a second cost

Claims history affects future pricing in most lines of insurance, so a modest claim can be followed by higher premiums for several renewals afterwards.

The combined effect of an excess and a rating consequence is that small losses are frequently absorbed rather than claimed, which the pricing already assumes will happen.

Understanding that is what makes an excess legible. It is a filter that decides which losses the scheme is meant to handle, set at the point where pooling stops being worthwhile.