What Is Insurance Excess?

Actuarials

Insurance companies collect all kinds of detailed information based on the past history of claims that have been collated, cross-collated, filtered and analyzed to develop an actuarial table. Among the information that is evaluated is the age, sex, race and driving experience of whoever is behind the wheel, the make of the vehicle, its age, the metropolitan or rural area where the driver lives, and the susceptibility of the vehicle to damage or theft. That, plus additional information, establishes the likelihood of a claim being made and its cost. These factors are just part of the considerations that are used in determining risk. From all this, insurance companies develop a probability on which to base their premiums to cover the cost plus what they consider a fair return for shouldering the risk.

Insurance is based on the principle of shared risk. Not just automobile insurance, but the same principles apply to life insurance, health insurance, home insurance...any kind of insurance you buy. The principle of shared risk relies on the law of large numbers. The idea is that the larger the number of people sharing risk, the less the chance of catastrophic loss by any single person. So your automobile insurance isn't only based on the factors applying to you directly, such as age, sex, type of vehicle, demographics, etc., but also on those same factors spread among a large number of people. So your house may not burn down, but a fraction of the risk of your neighbor's house burning down is factored into your premium.

If you purchase a vehicle with a value so high that your insurance company cannot insure you entirely because the premiums would be excessive, the insurance company can sell a portion of the liability over a limit to a secondary underwriter. Though the odds that the damage would ever exceed the primary insurance are remote, the underwriter is willing to reimburse the excess amount over a certain limit at a lesser premium because the actuarial odds are so low that the lower premium is warranted when spread over large numbers.

As the buyer of insurance, your choice must be balanced between how much risk you are willing to share with the insurance company (your deductible) versus the amount of the premium. If your goal is to pay as little as possible in premiums, you want a high excess (deductible). In other words, the cost of repairing the damages up to an agreed upon limit come out of your pocket first. The rest is covered by the insurance company.

If you want low premiums but complete coverage, obtain a policy with the highest deductible (excess) coverage you want to pay. The thing about paying for insurance is that you may never need it. So if you own a vehicle for 10 years with no claims and have paid premiums of $1,000 a year, you've spent $10,000 for nothing but peace of mind. Instead, cut your premiums to a bare minimum with a high excess (deductible) and get a credit card dedicated solely to pay for damages to the vehicle in the event of an accident. Put it in the glove box and leave it there. It requires some willpower, but it serves the same purpose as insurance without the premiums unless and until you need them. If there is no damage and no claims, you've paid the least you could possibly pay for peace of mind. If there is damage, you begin paying the premiums in the form of repayment on the credit card only when the worst occurs.