Why do we pay an insurance excess?

We buy insurance to secure protection for ourselves when we suffer a property loss or damage which we cannot afford to repair or replace out of pocket. When a claim is presented and the insurer agrees to settle, the insured must pay the first amount payable or excess before a settlement is made. Why?

The purpose of an excess payment

The enforcement of an excess on an insurance claim serves numerous purposes, including the following: An excess is imposed in an effort to avoid small value and quite possibly frivolous claims. Where the insured is required to pay a contribution on a small loss, they may be less inclined to make such a small value claim. Further to this, such claims place additional pressure on claims administration and claims costs which invariably do not compare favourably against the value of the claim.

Payment of an excess will also discourage the submission of exaggerated or false claims. This is particularly relevant where an excess is calculated as a percentage of a loss. The insured would be more inclined to submit claims more responsibly and more conservatively.

Where an insured is expected to contribute to a loss by payment of an excess, they will be encouraged to exercise a greater degree of care and maintenance of the insured property to minimise the possibility of a claim.

Payment of an excess will reduce the value of loss amounts reflected on the insured claims history and so have a positive effect on the overall loss ratio of the policy. An improved loss ratio leads to a more favourable risk and insurance terms.

Excesses will often be specific to a particular type of event (e.g. fire, lightning or water) together with an ‘All Other’ excess covering all unspecified events. In some circumstances, more than one excess could apply to a particular claim event. In such cases, the insurer applies the excess most appropriate to the proximate cause of the event and/or whichever is the higher of the two excess amounts.

Cumulative excess

A further option could be a ‘cumulative’ excess. When an excess is marked as ‘cumulative’, this means that this excess is imposed ‘in addition to’ any other appropriate excess payable. Such excess is commonly applied to claims including higher risk or higher claim frequency property such as wooden or laminated flooring. Where such a ‘cumulative’ excess is applied, it should only be applied to that portion of the claim that fits within the cumulative excess description.

In certain circumstances, insurers may utilise the determination of the excesses as a means to maintain lower risk and/or lower premium contributions. By increasing the excess, the value of claim payments is reduced. This in turn lowers the financial risk to the insurer and has a positive impact on the policy loss ratio.

If there is a silver lining to the excess payment, it would be that by being a contributor to the claims costs, the insured is actually having a positive impact on their overall risk profile.