Liability Deductibles and Self-insured Retentions
Many commercial liability policies include a deductible or a self-insured retention. Both are types of self-insurance. They transfer some of the risks of losses that the insurer has assumed back to the policyholder.
Mandatory or Optional
A deductible or SIR may be incorporated into a policy or added via an endorsement. It may be mandatory (required by the insurer) or optional. An insurer may be unwilling to provide a certain coverage without a deductible or SIR. An example is a commercial umbrella policy. Umbrellas offered by many insurers include a SIR. If you want to buy a policy you must accept the SIR.
A deductible or SIR may also be required if your company has a poor loss record or is involved in a hazardous occupation. For instance, general liability policies sold to roofing contractors often include a mandatory deductible on property damage claims.
In some cases, a deductible or SIR may be available as a option for lowering your premium. Deductibles are used for this purpose in workers compensation insurance. SIRs are often used in general liability insurance. Many large businesses save money on their liability premium by choosing a policy with a SIR of $100,000 or more.
While a deductible and a SIR serve similar purposes, they have some key differences. These are outlined below.
One distinguishing feature of a deductible is that it reduces the amount of insurance available. For example, suppose that your general liability policy includes a $5,000 deductible on property damage losses. Your Each Occurrence limit is $500,000. You accidentally cause a massive fire that results in a $505,000 property damage claim. Your insurer pays $495,000 ($500,000 limit minus the $5,000 deductible). You are responsible for the $5,000 deductible plus the $5,000 in damages that exceed the limit.
Because the deductible is subtracted from the limit, the entire limit is not available to cover the loss.
When included in a liability policy, a deductible usually applies to damages only. The insurer handles your defense and pays all claims expenses. These expenses are not subject to the deductible. In the example described above, suppose that your liability insurer pays $50,000 in legal expenses to settle your property damage claim. The legal expenses will not be included in the deductible. Your insurer pays them as Supplementary Payments in addition to the $495,000 in damages.
Unlike a deductible, a self-insured retention does not reduce your limit of insurance. Once your SIR has been satisfied the entire limit is available to cover claims. SIRs are often found in errors and omissions (professional liability) policies.
In the previous example, suppose that your general liability policy includes a $5,000 SIR instead of a deductible on property damage claims. Your policy limit and the amount of the claim are the same as above. In this case, you will pay the first $5,000 in damages (your SIR) and your insurer will pay the remaining $500,000 (the policy limit). The SIR does not reduce your limit.
A SIR may apply to damages only or to damages and claims expenses. When claim expenses are included, your policy should specify whether you or your insurer is responsible for handling claims. Typically, your insurer will manage the claim and then bill you for your portion of the claim expenses (your retention amount). Some policies may state that you are responsible for handling claims until your SIR has been exhausted.
Terminology Not Exact
The terms deductible and self-insured retention are not always used in a consistent manner. A policy may contain a "deductible" that acts like a SIR. The reverse is also true. Thus, it's important to read your policy carefully. If you don't understand how a deductible or SIR affect your coverage, ask your agent or broker for assistance.