Insurance Explainer: The Economics Behind Insurance Excesses — Moral Hazard, Risk Sharing, and What UK Policyholders Actually Pay

The concept of an insurance excess — known as a deductible in American terminology — is fundamentally a solution to an economic problem called moral hazard. Moral hazard occurs when a person who is insured against a risk behaves differently than they would if they bore the full cost of that risk. A homeowner with zero-excess contents insurance, for example, might be less careful about locking doors or securing valuables, knowing that any loss would be fully covered.

By requiring policyholders to bear a portion of every claim, excesses align the interests of the insurer and the insured. You retain a financial stake in preventing loss, which encourages prudent behaviour. Academic research in insurance economics consistently shows that higher excesses correlate with fewer small claims, which reduces administrative costs for insurers and, in turn, keeps premiums lower for everyone in the risk pool.

The second economic force at play is adverse selection. Without excesses, people who know they are likely to claim — perhaps because they live in a flood-prone area or drive in congested cities — would disproportionately buy insurance, driving up costs for the entire pool. Excesses act as a screening mechanism: policyholders who are confident they will rarely claim are willing to accept higher excesses in exchange for lower premiums, while those who expect to claim frequently prefer lower excesses even at a higher premium. This self-selection helps insurers price risk more accurately.

The Association of British Insurers (ABI) provides further reading on how risk-sharing works. Together, these mechanisms mean that excesses are not simply a way for insurers to avoid paying out — they are a structural feature that makes the entire insurance market function more efficiently.

In the UK insurance market, excesses come in two forms: compulsory excess and voluntary excess. The compulsory excess is set by the insurer and cannot be negotiated — it reflects the insurer's assessment of your risk profile. The voluntary excess is an additional amount you choose to pay on top, typically in exchange for a reduced premium.

For motor insurance, compulsory excesses typically range from £100 to £350 for experienced drivers, but can exceed £1,000 for drivers under 25 or those with recent claims. Adding a voluntary excess of £250 to £500 can reduce annual premiums by 10% to 20%, depending on the insurer and your risk profile. According to the Association of British Insurers (ABI), the average UK motor insurance premium reached £635 in 2025 — understanding how insurers set these prices requires looking at the loss ratio and combined ratio, making even a 10% reduction meaningful.

Home insurance excesses work similarly. Buildings insurance typically carries a compulsory excess of £100 to £250 for standard perils, but subsidence claims usually have a separate, much higher excess — commonly £1,000 — reflecting the costliness and complexity of these claims. Contents insurance excesses are generally lower, often £50 to £100 for compulsory, with voluntary excesses up to £500 available.

Travel insurance excesses tend to be lower in absolute terms — typically £50 to £100 per claim for medical expenses — but they apply per claim per person, which can add up quickly for families. Pet insurance excesses range from £50 to £200 per condition, with some policies also applying a co-payment percentage for older animals.

For more on this topic, see our guide to Why Do Insurance Policies Have Excesses.

The decision to raise your voluntary excess is essentially a bet on your own claim frequency. If you increase your home insurance excess by £250 and save £60 a year on premiums, the trade-off pays for itself in just over four years without a claim. For a careful homeowner who claims less than once a decade on average, this is a clear financial win.

The mathematics becomes even more compelling for motor insurance. A driver who raises their voluntary excess from £100 to £500 might save £80 to £120 annually. Since the average UK driver makes a motor insurance claim roughly once every seven to eight years, the cumulative premium savings over that period far exceed the additional £400 excess you would pay in the event of a claim.

However, this calculation only works if you can afford to pay the total excess — compulsory plus voluntary — at short notice. Financial advisers typically recommend that your total excess should not exceed an amount you could comfortably find within 48 hours without resorting to credit. For someone with limited savings, a high voluntary excess that saves £50 a year but leaves them unable to claim when disaster strikes is a false economy.

There is also a psychological dimension. Research from behavioural economics shows that UK consumers who set high excesses and then experienced a claim often felt disproportionately negative about the experience, even when they had saved more in premiums than the additional excess cost. The perceived loss at the point of claim can feel much larger than the diffuse savings accumulated over years of lower premiums — a textbook example of loss aversion.

The Financial Conduct Authority (fca.org.uk) (FCA) has taken an increasingly active interest in how UK insurers set and communicate excess levels. Under the Consumer Duty, which came into full effect in July 2023, insurers must demonstrate that their products deliver fair value to customers. This includes ensuring that excess levels are clearly disclosed, proportionate to the risk, and do not create barriers to claiming that effectively render policies worthless.

The FCA's General Insurance (fca.org.uk/consumers/insurance) Value Measures reporting has highlighted concerns about claims acceptance rates and the role of excesses in discouraging legitimate claims. If a policy has a high excess relative to typical claim sizes — for example, a contents insurance policy with a £500 excess when most theft claims are for items worth £200 to £400 — the regulator considers this a potential fair value issue.

Insurers are now required to disclose excesses prominently in policy documentation, not buried in fine print. The Insurance Product Information Document (IPID), a standardised summary required across the EU and retained in UK law post-Brexit, must clearly state the applicable excesses for each type of claim. This transparency is designed to help consumers make informed comparisons.

It is worth noting that some insurers offer excess-free policies — particularly in the home insurance market — at a premium. These can make sense for policyholders who claim frequently or who would struggle to find the excess amount. However, the FCA has also scrutinised these products to ensure the additional premium charged is proportionate to the benefit provided.

Related reading: savings guide, tax planning guide.

Choosing the right excess level requires balancing three factors: your claim likelihood, your financial resilience, and the premium savings on offer. Here is a practical framework for UK policyholders:

First, check your emergency fund. If you have at least three months' expenses saved — the level recommended by most UK financial advisers — you can likely afford a higher voluntary excess. If your savings are minimal, keep excesses low even if premiums are higher. The whole point of insurance is financial protection, and an unaffordable excess undermines that purpose.

Second, compare the actual premium difference. Not all excess increases produce proportionate premium reductions. Some insurers offer minimal savings for higher excesses because their pricing models already account for the risk. Use comparison sites like MoneySuperMarket, GoCompare, or Comparethemarket to test different excess levels for the same policy and calculate the break-even period.

Third, consider the type of insurance. For motor insurance, where claims tend to be larger (the average UK motor insurance claim exceeds £3,000), a higher excess represents a smaller proportion of the typical claim value — making higher excesses more sensible. For contents insurance, where many claims are for smaller amounts (and where recoverable depreciation may also apply), a high excess may deter you from claiming altogether.

Finally, review your excesses annually. As your financial circumstances change — a pay rise, a house move, children leaving home — the right excess level changes too. Many policyholders set their excess when they first buy a policy and never revisit it, potentially paying too much in premiums or carrying an excess they can no longer afford.

This article is for informational purposes only and does not constitute regulated financial advice. If you are unsure about your insurance needs, consult a qualified financial adviser or insurance broker regulated by the FCA.