Insurance is a form of risk management.
Two parties – the insured and the insurer – share the value and liability of an asset. The insurer is remunerated by the insured in exchange for the guarantee of sharing liability in the event of unexpected loss.
It’s a concept that’s been in practice for many hundreds of years.
What is a policy excess?
Excess is part of the distribution of liability.
Suppose your home and contents are insured for events such as theft, vandalism, fire, escape of water, flood, accidental damage, and subsidence. The premium you pay is an agreed amount that remains constant for the duration of the policy. The value of a potential loss, however, is unpredictable.
Let’s say your home is broken into, and items worth £400 are stolen. You make a claim for the £400. If your insurance policy cites a £70 excess on these items, you’ll receive £330 from your insurer; if the excess is £90, you’ll be paid £310; if it’s £100, your payment will be £300, and so on.
Now let’s imagine that your home suffers subsidence. Work must be carried out to reinforce the foundations, and you need temporary accommodation during this time, amounting to tens of thousands of pounds in expenses. If you were to pay an excess of just £100, the financial burden would be unbalanced. Typically a policy covering subsidence might therefore have an excess of £1,000.
As a way of maintaining a consistent balance of financial risk between the insured and the insurer, an appropriate excess is ascribed to each potential event, based on the event’s predicted cost. That’s why a higher excess is ascribed to an event that’s typically associated with high financial loss.
“Why is my policy excess so high?”
A frequently asked question!
Insurance – or risk management – is about balance. We’ve looked at the balance of liability between the insurer and the insured. But the balancing act goes beyond that, to the insured party’s portion of the liability – i.e. premium plus excess.
An attractively low-premium insurance policy will, in most cases, go hand in hand with a large excess. A higher premium is associated with a smaller excess. The two are inversely related.
Compulsory excess and voluntary excess: what’s the difference?
Compulsory excess is the standard portion of a claim payable by the insured party. It’s an integral part of the basic insurance policy. You can’t choose a no-excess policy.
Voluntary excess is just what it says on the tin: an optional, additional policy excess. In the event of a claim, you pay the compulsory excess plus the voluntary excess. When you choose a higher excess, your premium will decrease.
What excess should I choose?
Premium payments are a certainty. Budgeting for the premium is straightforward, whether you’re paying it in one go or in monthly installments. You know exactly what you’ll be paying and when you’ll be paying it.
Events that lead to a claim, however, are uncertainties. Budgeting for a disaster is not an exact science. You don’t know it’s coming, and you don’t know how much it’s going to cost.
If you’re reasonably well off, increasing your voluntary excess could be an economical option. On the other hand, if a large, unexpected bill might potentially ruin you, then a lower excess (and higher premium) is probably the safer option. In some cases, voluntary excess can be changed during the term of the policy.
When choosing your level of voluntary excess, assume that you’ll need to make a claim within the insured period. Consider your ability to pay the excess.
How to choose an excess
It’s always tempting to opt for high policy excess in exchange for a low premium, especially if you’re strapped for cash – or exceptionally optimistic and certain that you’ll never need to make a claim! (Just a word of warning: if you do feel like this, ask yourself why you’re taking out an insurance policy.)
Okay, so we’ve poked a little fun at the optimist, but there is some logic in weighing up the likelihood of a claim. For example, a home that has an outdoor light, burglar alarm, and CCTV system has a lower chance of being successfully burgled than a home with only an outdoor light. A house at the top of a hill is a less-likely candidate for flood damage than a house located on a riverbank.
When choosing your level of voluntary excess, consider:
- Your environment (physical and demographic)
- Your property (age, condition, and value)
- Your finances (what you can afford)
Ultimately, your choice must bring you peace of mind and a sense of security. Because that’s what insurance is all about.