Why do insurance policies have deductibles?
Insurance policies have deductibles for behavioral and financial reasons.
Deductibles mitigate the behavioral risk of moral hazards. A moral hazard describes the risk that two parties to an agreement or contract may not act in good faith. Because insurance policies protect the policyholder from loss, a moral hazard exists; the insured party may engage in risky behavior due to the protection provided by the insurance policy he holds.
For example, if a driver holds an automobile insurance policy, he may have incentive to drive in a reckless manner or leave his vehicle unattended in dangerous areas because he is insured against damage or theft. A deductible mitigates the risk that the insured party may engage in reckless behavior. The insured party is responsible for a substantial portion of the costs in the event of catastrophic loss along with the insurer. In effect, deductibles serve to align the interests of the insurer and the insured so that both parties seek to mitigate the risk of catastrophic loss.
Insurance policies also use deductibles to ensure a measure of financial stability on the part of the insurer. A properly structured insurance policy should protect against catastrophic loss. A deductible provides a cushion between any given minimal loss and a true catastrophic loss that allows the insurance company to administer its policies.
For example, suppose an insurance policy did not have a deductible in place. The cost of every minor claim, regardless of the severity of loss, would be the responsibility of the insurer. Any small dent in an automobile or minor property damage on a home would create a claim the insurer must address. This scenario would create an overwhelming number of claims and increase the financial costs of the policy, damaging the ability of the insurer to respond properly to actual catastrophic losses from policyholders.