What it means
In insurance language, a franchise is an amount below which a loss is not paid. If the franchise is $1,000 and your loss is $800, you receive nothing.
If your loss is $5,000, the insurer pays the whole $5,000, not just the $4,000 above the threshold. A deductible works differently, because it is always subtracted from the payment.
Under a $1,000 deductible, a $5,000 loss produces a payout of $4,000. The franchise is therefore more generous on larger claims, and premiums for cover with a franchise are usually higher than for the same threshold as a deductible.
Insurers like franchise structures because they remove the cost of handling many small claims, which can cost more to process than they are worth. Policyholders like them because major losses are covered in full.
The approach has long been used in marine and cargo insurance, and is also found in some health and travel policies. For a business, the choice of threshold matters.
A higher franchise lowers the premium but increases the number of small losses the company must bear on its own, so it should be set at a level the business can absorb from its normal cash flow. Risk managers often review claims history to find the level that balances premium savings against retained losses.
The term franchise cover can also be heard in a different sense in the franchising industry, where it refers to insurance programmes designed for franchisees and franchisors. These typically bundle liability, property and business interruption cover.
Always read the policy wording to understand which meaning applies.
In practice
Real-world examples.
Example
A freight company insures its cargo against damage with a franchise of $2,000 per shipment. A shipment is damaged by $1,500 of water and the company bears the loss. A second shipment suffers $9,000 of damage and the insurer pays all $9,000.
Example
A manufacturer is offered two policies for its machinery. One has a $5,000 deductible and one has a $5,000 franchise, and the franchise policy costs 12% more. The risk manager compares past claims and chooses the franchise because it has had several large losses.
Example
A travel insurer sells a medical policy with a franchise of $200 per claim to avoid paying for minor treatments. Customers like the clear full cover for serious illness. The insurer's claims team spends less time on small claims. As a result the insurer is able to keep its administration costs lower and offer a competitive price on the cover.
Formula
Calculation
Payout under a franchise = Loss if Loss is greater than the franchise, otherwise 0
Payout under a deductible = Loss - Deductible, if positive
Suppose a policy has a franchise of $10,000. A loss of $8,000 gives a payout of $0. A loss of $30,000 gives a payout of $30,000.
Under a $10,000 deductible, the same $30,000 loss would pay 30,000 - 10,000 = $20,000. The franchise policy therefore pays $10,000 more on that claim, and the policyholder would normally pay a higher premium for it.Case study
Seen in the real world.
Bluewater Seafoods is a fictional exporter that ships frozen fish in refrigerated containers. Its insurance broker offered a cargo policy with a $3,000 deductible at a premium of $60,000 a year, or a policy with a $3,000 franchise at $72,000.
The risk manager studied last year's claims, which included 20 claims below $3,000, 4 claims of about $10,000 and 1 claim of $50,000. Under the deductible, recoveries would be 4 x 7,000 + 47,000 = $75,000, while under the franchise they would be 4 x 10,000 + 50,000 = $90,000.
In this illustrative example the franchise gave $15,000 more recovery for $12,000 more premium, a small net gain of $3,000. The risk manager chose the franchise policy, but noted that the result would reverse in a year with fewer large claims. She also asked the broker to review the threshold every year, since a franchise set too high would leave the company paying too many mid-sized losses from its own cash, and one set too low would push the premium up without much benefit.
Watch out
Common mistakes.
- Treating a franchise as a deductible, when a franchise pays the full loss once the threshold is passed.
- Choosing the lowest premium without checking how many small losses the business will have to absorb.
- Assuming a franchise policy is cheaper, when it usually costs more than a deductible of the same size.
Questions
People also ask.
What is the difference between a franchise and a deductible?
A deductible is subtracted from every claim, while a franchise is paid in full once the loss exceeds the threshold and not at all if it falls below.
Why do insurers offer franchise cover?
It removes the many small claims that are costly to process, and the premium reflects the full payment on larger losses.
Does franchise cover also mean insurance for franchisees?
In some contexts it does, as insurers use the phrase for programmes aimed at franchise businesses, so read the policy wording carefully.
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