Liability Deductibles and Self-insured Retentions
A Deductible Reduces Your Limit While An SIR Does Not
Deductibles and self-insured retentions are often used in commercial casualty insurance. Both are types of self-insurance. They enable policyholders to retain some of the risk of losses in exchange for a lower premium.
Optional or Mandatory
A deductible or self-insured retention (SIR) may be added a policy via an endorsement at the insured's request. For example, a business owner asks his insurer to enroll his firm in a small deductible plan so he can lower the premium on his workers compensation policy.
In some cases, a deductible or SIR may be required by the insurer as a condition of coverage. An insurer may impose this requirement if the insured has a poor loss history or conducts a business in a hazardous occupation. For instance, an insurer may agree to provide general liability insurance to a roofing contractor only if the policy includes a property damage deductible.
In some policies, a deductible or SIR is incorporated into the coverage form. If you want to buy the policy, you must accept the SIR. For instance, a typical directors and officers liability policy automatically includes an SIR that applies to Indemnification (Side B) and Entity (Side C) Coverages. The SIR is usually mandatory so the insurer won't remove it.
While deductibles and SIRs serve similar purposes, they have some key differences. These are outlined below.
When a policy includes a deductible, the insurer is responsible for paying claims. Typically, the insurer pays each claim and then bills the insured for the deductible amount.
A distinguishing feature of a deductible is that it reduces the amount of insurance available. For example, suppose that you operate an electrical contracting business. Your company is insured under a general liability policy that includes a $500,000 each occurrence limit and a $5,000 property damage deductible. You accidentally cause a massive fire at a customer's business location. The fire generates 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 $500,000 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.
When a policy includes an SIR, the insured is generally responsible for paying claims that fall within the retention. The insurer is not obligated to pay claims until the SIR has been satisfied. Large businesses often choose a liability policy that includes an SIR because they want more control over the claims payment process. An SIR is automatically included in many errors and omissions (professional liability) and commercial umbrella policies.
Another key difference between an SIR and a deductible is that the former does not reduce your limit of insurance. When your retention has been satisfied, the entire limit is available to cover claims.
For example, in the electrical contracting scenario described above 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. In this case, you will pay the first $5,000 in damages (your SIR) out of pocket and your insurer will pay the remaining $500,000 (the policy limit). The SIR does not reduce your limit.
An 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 consistently. A policy may contain a "deductible" that acts like an 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.