Jay on Twitter asks Dave how to determine the amount of the deductible on your home insurance. Dave explains how this can be accomplished through a simple break even analysis.
QUESTION: Jay on Twitter asks what is the best formula to use in determining at what amount to set his homeowners insurance deductible. Dave explains that it begins with a break-even analysis.
ANSWER: You do a break-even analysis. The way you do that is take a current deductible that you have, and let’s say you have a $250 deductible. Your premium is “X,” so you ask them what is the premium at a $500 or $1,000 deductible. Let’s say your premium is $500 a year cheaper with a $1,000 deductible. Well, you’re taking $750 more risk but you’re saving $500 a year. How often do you have a homeowners claim? If you have one once a year, you’re probably going to have a different homeowners policy.
So, you’re going to make that money back in the second year even if you had a claim and every year thereafter put $500 in your pocket. That makes sense. But let’s say you went from $250 to $1,000 and your savings was $75 a year. Well, that means you have to go 10 years, 750 divided by 75, you’d have to go 10 years without an event. That’s not likely to happen. At that point, you go ahead and keep the $250 because it’s a good buy.
Most of the time the deductible gives you a break even — the extra risk you’re taking of a higher deductible breaks even with your savings —somewhere in the two to three year mark most of them time, unless you’re just accident prone and you’re constantly having something happen. But that’s how you do it, though. You do a break-even analysis on the extra risk you’re taking.