Describe the purposes of deductibles.

Expert Solution

Deductibles are your own out of pocket expenses that you need to pay for before the insurance companies start paying. These are the quantum of expenses that should be paid by you, out of your own pocket, before the insurance companies start paying.

Purpose:

To remove the moral hazard problem: If there are no deductibles, the insured will always try to inflate the claims and demand higher claims for settlement with the insurance companies. Presence of deductibles mean you have to bring in your money first. Hence, you will not tend to inflate the claims.
To have the skin of the insured in the game: The insured will fraudulently produce insurance claims. Since you have to bring your own contribution first, due to deductibles; the probability and occurrences of such fraudulent acts will reduce.
Higher the deductible, lower will be the premium for the policyholder. Thus the cost of insurance will go down.

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