Deductibles and self insured retention (SIRs) are tools that reduce your insurance premiums, where you to share the cost of a loss. While these two mechanisms are economically similar, they vary significantly and are not interchangeable.
Deductibles & Self Insured Retentions, What are They?
What is a Deductible?
A deductible is the part you pay as part of your insurance policy. In most business-related insurance policies, the insurance carrier is responsible for paying 100% of a claim, and they will bill you after the fact for your portion of the deductible.
What is Self-Insured-Retention?
A self insured retention is similar to a deductible, but you pay the self insured retention amount first before the insurance company begins paying.
Let’s say you have a liability policy that protects against your company going through a lawsuit. Under a self insured retention, you begin paying your legal fees and costs for defending the lawsuit. Once you have met the self insured retention amounts in your policy, your insurance policy will begin coverage.
Defense Issues – Who Controls a Lawsuit under Deductible or SIR?
One of the key differences between self insured retention vs deductibles is who is responsible for defending claims – at least for the first part.
A deductible clause of a policy requires your insurance company to review each claim. If a liability is theoretically protected by the policy, the insurer is obligated to take over the insured’s defense as soon as possible. The insurance carrier’s claims management controls every claim under these insurance policies.
With a self insured retentions, the insurer does not necessarily get involved until the self insured retention requirement is met. You are responsible for the defense costs until you meet the self insured retention amount.
For example, let’s say you have a $1M policy with $100K of SIR. For small claims under $100K, you might handle the issues with your own attorneys and may not invoke your insurance policy at all. By handling the small issues yourself, you avoid having a claims history that might increase your future premiums.
If you have a deductible policy, you would inform the insurance carrier of every issue, even a smaller one of $50K, which might be below your $100K deductible. The insurance carrier will handle the issue and you will still pay your portion of $50K.
Under a self insured retention policy, you control any lawsuit until it exceeds the SIR requirements. Once you have met the self insured retention requirements, you can turn over the lawsuit to your insurance company, and the insurer pays the remaining defense costs.
Under a deductible policy, your insurance company controls the lawsuit from the beginning.
With a self insured retention insurance policy, an insurance company might be concerned about how you might handle the lawsuit and may retain its own legal counsel to track your defense. This might happen when the lawsuit might exceed the SIR limits and the insurance company would begin paying.
Deductibles and SIRs Change the Amount of Coverage
Self insured retention vs deductible policies work in a different way from each other when calculating how much protection you have.
A $1M policy with a $100K deductible amount provides protection after you spend $100K, but the insurance company pays up to $1M total. This means the insurance company pays $900K – the difference after your $100K deductible is met until the $1M is reached. After the $1M of defense costs is reached, you are responsible for any further expenses.
Contrast this to an SIR policy.
A $1M policy with a $100K SIR does not kick in until $100K is spent. After you spend $100K, the insurance company will pay claims for another $1M. This means you will have protection for defense costs until $1,100,000 is reached, after which you are responsible for any further expenses.
Deductibles erode the amount of protection, but SIRs typically do not.
In our example, a $100K deductible on a $1M policy really means that the insurance company will pay a maximum of $900K. With an SIR, the insurance company will pay a maximum of $1M.
Deductibles Might Require a Bond
For very high deductible policies, the insurance company begins paying right away, but they are on the hook for your deductible – until they collect from you. Let’s say your company had a $500K deductible, which might be OK when you are looking for the insurance company to take on the very expensive lawsuits, but you decide you can handle the smaller ones.
In this scenario, the insurance company may require you to post bond or give some other surety that you will, indeed, pay your deductible. For a Self Insured Retention, no bond would be necessary. This is because you are responsible for the self insured retention before the insurance company begins to pay.