When should you raise deductibles?

This post comes from Trent Hamm at partner blog The Simple Dollar.

One common, painful bill that we all face is the insurance bill. Whether you’re talking renters insurance, homeowners insurance, or automobile insurance, the bill feels painful because it’s not something we can often see the benefit of. It just comes in handy when something goes wrong.

One of the most common tactics you’ll see in cost-cutting articles is calling up your insurance company and requesting an increase in your deductible -- the amount you have to pay before the insurance kicks in.

On the surface, this works well. If you increase your deductible, your premiums (the amount you pay each month/quarter/year) will go down, meaning your insurance bills are lower. You can chip a hefty percentage from your insurance bill just by making this move.

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One of my longtime readers, Jeanne, has been writing to me about insurance this week. She has considered doing this, but something is convincing her that it’s not the best move:

I understand that raising a deductible will lower your premiums. But why do we have insurance in the first place? Doesn’t raising the deductible through the roof defeat the purpose?

The first thing to note here is that the purpose of insurance is to insure that you’ll survive financially in case of an unforeseen event. We have homeowners insurance because it will help us start over with a new home should our house burn to the ground.

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Without it, most of us would sink financially. The same goes for renters insurance: It’d be tough to lose all of your possessions in a fire without any way to recover. Without auto insurance, if you total your car you might be left with a car loan and nothing to show for it.

Secondly, saving money by raising a deductible assumes that you have the cash on hand to cover the deductible if the need arises. If you raise your auto deductible from $200 to $1,000, you’ll see a big drop in your bill, but if something goes wrong with your car, you’re going to need that $1,000. If you don’t have that $1,000 in an easy-to-access place, then you’re in real trouble.

The solution is simple: If you have a well-funded emergency fund in a savings account, you can raise your deductibles without worry. A well-funded emergency fund means a minimum of a couple months’ worth of living expenses, plus more if you have dependents. If you have that kind of cash that can be accessed with ease, then by all means, raise your deductibles.

Won’t this cost me more in the long run? Many people who consider this ask themselves that question. After all, if they’re having to come up with a lot more money on each claim, are they really saving money overall?

The average homeowner makes an insurance claim once every nine years. If you raise your deductible on your homeowners insurance by $1,000, you only need to save about $120 a year on your premiums in order to create a net savings on average -- and, likely, you’ll save a lot more than that.

• Bing: How high should my deductible be?

Similar math applies for other types of insurance. Claims are so infrequent that you only have to save a little bit on each insurance payment to make up for the additional cost of the deductible.

The key, though, is making sure you have the emergency savings to handle that higher deductible. If you don’t have that, make it a priority before you consider making changes to your insurance policies.

Related reading at The Simple Dollar:

• When should you downgrade your car insurance?
• Auto insurance bill got you down? 7 things to consider
• 31 days to fix your finances: Day 16