Self-Insured Retentions versus Deductibles
May 2009
While many of you know the difference
between self-insured retentions (SIRs) and deductibles, many more of you
think you know the difference. And some
of you didn't know there was a
difference between SIRs and deductibles. This brief article is for the
latter two categories.
by Donald
J. Riggin
Albert Risk
Management Consultants
SIRs and deductibles, while quite different, are designed to accomplish
the same goals. Each imposes a specific layer of risk onto the insured,
almost always the primary layer, above which insurance limits attach. In
each case, the premium for the insurance directly excess of the SIR or
deductible is credited to reflect the fact that the insured is assuming some
amount of primary risk. This, however, is where the similarities end.
The major differences between SIRs and deductibles concern (1) insurer
responsibilities in the event of a loss, (2) collateral requirements, (3)
defense costs, (4) certificates of insurance, and (5) limits erosion.
Insurer Responsibilities in the Event of a Loss
Under an SIR, the excess insurer generally has nothing to do with losses
that do not penetrate its attachment point. The insurer may, however,
require notification when a claim is reserved for an amount that pierces the
attachment point. Under a deductible, however, the insurer pays every loss
(up to the maximum limit of liability), and is then reimbursed by the
insured up to the amount of the deductible. In practice, small losses are
simply paid by the insured to avoid the "dollar-trading" problem.
Collateral Requirements
Insurers require collateral in situations wherein they assume credit
risk. That is to say, in situations where the insured cannot pay a loss, the
insurer is obligated to step in and pay the loss. In SIRs, because the
insurer has no responsibility for paying losses until the SIR is exhausted,
there is generally no collateral requirement. Conversely, large deductibles
very often require that the insured provide a letter of credit (LOC) or some
other acceptable form of collateral to cover expected losses that occur
within the deductible.
For example, let's say that you have a $250,000 per-occurrence deductible
on your workers compensation coverage. Your expected losses from $0 to
$250,000 amount to $1 million. Your collateral requirement might be $1
million, but more likely it will be some multiple of this figure, perhaps
150 percent of $1 million. If your program has an annual aggregate limit,
you may be required to provide collateral up to and perhaps exceeding this
limit. So why wouldn't everyone simply opt for an SIR and avoid the
collateral issues?
Workers compensation and in some cases, automobile liability, are only
available on a deductible basis because state law requires insurers to pay
claims on a first-dollar basis unless the insured is a qualified
self-insurer, in which case it must post a self-insurer's bond with the
state. For most other coverage lines, an SIR is used most frequently.
Defense Costs
Under the standard, garden variety insurance policy, the costs to defend
claims are included as supplementary payments and do not erode the policy
limit. This is generally the case with small deductibles, but in the large
deductible world (over $100,000), whether defense costs erode the deductible
is subject to negotiation; they usually do. Under an SIR, the question of
who pays for defense costs and whether the SIR is eroded is moot—the insured
pays all expenses associated with defending claims until the loss exceeds
the SIR and its amount is not eroded.
Certificates of Insurance
Here is one of the reasons why insureds might choose a deductible over an
SIR. Remember that under a deductible, regardless of how claims are paid,
the insurer is ultimately responsible for paying losses. This means that a
certificate of insurance need not divulge the fact that a deductible
applies. Conversely, SIRs must be divulged on insurance certificates as the
insurer has no responsibility to pay claims until the SIR is exhausted. Some
certificate holders, banks, for instance, often demand to know the amount of
any deductible or SIR regardless of whether it must be divulged.
Limits Erosion
Under an SIR, the policy's annual aggregate limit is usually not affected
by the SIR amount. Let's assume that your aggregate SIR under your general
liability policy is $1 million, and your total policy limits amount to $10
million. You would have $10 million of coverage excess of $1 million SIR.
Under a deductible, the annual aggregate limit is usually eroded by the
amount of the deductible. In the same scenario, in a deductible plan, your
total limit of liability would also be $10 million, but $9 million of it
would be available from the insurer, and you would be responsible for the
initial $1 million.
Here is a handy checklist of the above five features.
|
Deductible |
SIR |
| Insurer Responsibilities in the Event of
a Loss |
Yes |
No |
| Collateral Requirements |
Yes |
No |
| Defense Included in Limit |
Yes (usually) |
No |
| Ability to Certificate |
Yes |
|
| Limits Erosion |
Yes |
No |
Unless restricted by law, most insureds opt for SIRs over deductibles.
However, not every insurer allows SIRs. Many of the admitted multiline
insurers require deductibles because it means that they're involved in every
significant claim. Insurers know that without effective loss adjusting and
claims management, small claims can quickly become large claims. These
insurers generally don't unbundle their services, meaning that they retain
the right to adjust each and every loss, as well as manage the claims
portfolio and provide legal services. Non-admitted specialty insurers,
however, are far more likely to permit SIRs. In fact, most non-admitted
insurance companies are not equipped to handle each and every claim, so an
SIR suits their purposes quite nicely.
Conclusion
In these days of
ultra-tight credit, collateral can be a major headache. Some insureds would
rather use a non-admitted insurer and go with an SIR to avoid having to post
letters of credit under a deductible plan. This strategy is, of course, not
an option for workers compensation.
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