Franchise Deductible: How It Works and When It Applies

Key Takeaways

• A franchise deductible requires losses to exceed a specific threshold before the insurer pays the full amount.
• Unlike ordinary deductibles, policyholders pay nothing once the loss passes the deductible.
• Franchise deductibles are common in commercial and high-value policies, offering full coverage above the set limit.
• There are different types of franchise deductibles (flat and percentage-based) that affect claim payouts differently.
• Contract terms should specify how and when the deductible applies, and if it’s subject to limitations or exceptions.
• Tax considerations and risk management strategies can impact how businesses use franchise deductibles in their insurance planning.

Franchise deductible refers to a kind of deductible in which a minimum amount of loss must occur in order for insurance coverage to become active. Once the deductible is met, insurance covers the entire amount of the loss. If the amount of damages is less than the required deductible, the insured party is responsible for payment.

Franchise Deductible

"Franchise" is an insurance term that refers to the minimum financial responsibility of an insurance company. If covered under an insurance policy with a franchise deductible, the insured party is liable for damages less than the set franchise value, or franchise deductible. However, when the losses are greater than the franchise deductible, the insurance company provides full coverage, or the entire amount of the loss. A "franchise" exists when an insurer is not held liable for loss that doesn't exceed an agreed amount, but becomes liable for the entire sum of a loss that does exceed the predetermined amount.

The term "excess" defines the amount of a claim covered by the insurance company. Losses equal to the excess amount are not covered by the insurer. On the other hand, when losses are more than the limit, the insurance company becomes liable. An excess exists when the insured party agrees to be responsible for a set amount of loss, and the insurance company is only responsible for covering amounts over the agreed amount of loss. The terms "franchise" and "excess" are included in insurance policies to clearly define and reduce the monetary obligations of insurance companies.

How Franchise Deductibles Work in Practice

Franchise deductibles operate on an all-or-nothing principle. If a claim amount falls below the deductible threshold, the insurer pays nothing. But if the claim meets or exceeds the set threshold, the insurer pays the entire amount—not just the amount over the deductible.

For example, with a $10,000 franchise deductible:

• A $9,000 loss would result in no insurance payout.
• A $10,000 or $15,000 loss would be fully covered by the insurer.

This approach is designed to eliminate minor claims while ensuring complete compensation for significant losses. It's often used in commercial insurance where businesses are willing to absorb smaller losses in exchange for reduced premiums.

Franchise Deductible vs. Ordinary Deductible

With an ordinary deductible, the amount of money stated in the policyholder's contract that must be paid before the insurance company contributes to the claim. In an ordinary deductible, the loss amount is subtracted from the deductible in order to determine payment. If that amount is less than the deductible, the insurance company will not cover any of the damages.

A franchise deductible differs from an ordinary deductible in regards to coverage protection. A claim must exceed a fixed dollar or percentage amount for the insurer to be responsible. When the loss is more than the franchise deductible, the insurer must pay the loss in full. This differs from an ordinary deductible, where even if the losses exceed the deductible, the policyholder must still pay the amount of the deductible before the insurer will contribute to claims of any size. Companies that have opted for insurance options with franchise deductibles are usually very large and typically involve commercial concerns.

Types of Franchise Deductibles

Franchise deductibles generally fall into two categories:

1. Flat Franchise Deductible:
   • A fixed dollar amount (e.g., $25,000).
   • Coverage activates once losses meet or exceed this amount.
2. Percentage-Based Franchise Deductible:
   • Calculated as a percentage of the insured value.
   • Common in high-value property or catastrophe coverage.
   • For example, 5% of a $2 million property = $100,000 deductible.

This structure allows insurers and businesses to align coverage with risk tolerance. The higher the franchise deductible, the lower the insurance premiums—but the greater the financial risk in low-loss situations.

Determining Deductibles

Insurance companies aim to avoid, or at least minimize, their exposure to risk. This applies even more than usual when these companies are insuring businesses in the retail sector, where goods are more frequently damaged than in other areas of business. Deductibles are determined by the insurance company assessing potential risks, the current state of the business market, and other industry factors. A deductible aims to save insurance companies money by freeing them from having to respond to minor losses, which in turn motivates insured parties to try to avoid losses. Once the insurance company has determined a specific dollar or percentage amount for the deductible, both parties must agree on the dollar number or percentage, which should be clearly defined in the insurance policy.

Risks that insurers face, and may consider in determining a deductible, include:

• Property damage:
  • Fire.
  • Loss to personal property or building.
  • Theft of equipment or property.
  • Loss of a computer or intellectual data.
• Business liability:
  • Accidents in the workplace.
  • Advertising slander.
  • Loss of business income.
• Business product liability:
  • A defective or harmful product.
  • Product recall.
  • A product's potential to cause damage.
• Business auto liability:
  • Employees traveling in company-owned vehicles.

Industry Applications of Franchise Deductibles

Franchise deductibles are more commonly used in certain industries and policy types, such as:

• Property insurance for large commercial buildings or infrastructure.
• Marine and cargo insurance, where single losses can be significant.
• Business interruption insurance, especially where full recovery is essential.
• Health insurance, in certain international policies.

In these contexts, the deductible helps reduce administrative costs for insurers by avoiding frequent low-value claims, while giving policyholders peace of mind for high-loss events.

Negotiating Contracts

When negotiating a contract, policyholders should consider several factors:

• The amount of the deductible.
  • A high deductible could be costly in the event that it is not met.
  • A lower deductible may include more policy fees that will increase overall policy cost.
• The different coverage plans available, in order to find the right amount of coverage with an affordable deductible.
• Quotes from other insurance agencies, which can be used as a means to negotiate a better contract.

Franchise Deductible Clauses in Insurance Contracts

When reviewing or negotiating contracts that include a franchise deductible, policyholders should:

• Define the deductible clearly, including whether it is flat or percentage-based.
• Specify whether taxes, fees, or depreciation apply toward meeting the deductible.
• Determine if multiple incidents are aggregated or treated separately for deductible purposes.
• Check for time limitations—e.g., if the loss must occur within a specific period to qualify.
• Understand any territorial exclusions or carve-outs in multinational policies.

Clarity in contract language is crucial to avoid disputes during claims processing. Legal review can help ensure the deductible clause aligns with your risk and financial strategy.

Frequently Asked Questions

1. What is a franchise deductible in insurance?
   A franchise deductible is a threshold that must be exceeded before an insurer pays the entire loss. If the loss is below that threshold, the insurer pays nothing.
2. How is a franchise deductible different from an ordinary deductible?
   With an ordinary deductible, the policyholder always pays a portion of the claim. In contrast, a franchise deductible requires no payment from the insured once the threshold is crossed.
3. When is a franchise deductible used?
   Franchise deductibles are commonly used in commercial insurance, marine policies, and property insurance where large, infrequent losses are expected.
4. Are franchise deductibles more cost-effective?
   They can be, especially for businesses willing to self-insure minor losses. They typically lead to lower premiums but carry more upfront risk for small claims.
5. What should be included in a franchise deductible clause?
   It should define the deductible type, amount, applicability, exceptions, and whether multiple events are aggregated.

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