Liability Deductibles and Self-insured Retentions

In today's hard insurance market, insurance buyers are looking for alternatives to reduce costs. A greater self-assumption of risk is often the first place companies are looking to accomplish that, with an eye toward ultimately becoming less dependent upon commercial insurance. Deductibles and self-insured retentions (SIRs) have always been available, but frequently were overlooked in the height of a soft insurance market.

For many, first dollar coverage has become a luxury they can no longer afford. As a result, more emphasis is being placed on catastrophic protection and, at the very least, a greater self-assumption of risk for smaller claims. When there is a high frequency of manageable claims, purchasing first dollar coverage just doesn't make financial sense, regardless of the insurance market conditions. Insurers collect premiums to cover such expected losses, and add the costs associated with claim expenses as well as a charge for their profit. This results in a trading of dollars for these claims, and the insurer always comes out ahead.

In virtually all cases, taking responsibility for your own moderate level of claims will be cost effective in the long run. Emphasis here is on the long run. Decisions to accept more risk should be made based upon long-term projected results. Businesses assuming more risk must understand that there will be years when they benefit from retention and other years when they will not be so fortunate. You should not be dissuaded from continued retention of losses simply because of one or two bad years of experience. Be assured that had those unexpected losses been insured, you would have to pay for them on a dollar-plus basis the following year.

When deciding to accept more risk through deductibles or SIRs, you must first understand the basic difference between the two approaches. Insurance policies written with deductibles provide that the insurer will pay the defense and indemnity costs in connection with a claim, and then charge back the deductible amount to the insured. The responsibility for the defense and settlement of each claim rests solely with the insurer, which maintains full control of the entire claim process.

Policies written with SIRs, on the other hand, place a large degree of (if not the entire) responsibility for claim payment and settlement on the shoulders of the policyholder. While language may vary, the insured is typically required to pay the defense and other allocated expense costs as well as indemnity payments until the amount of the retention is paid, after which the insurer assumes full responsibility for the claim.

Care must also be taken to understand the extent of risk being assumed. Whether you select a deductible or SIR, be sure to understand if it applies to each occurrence or to each claim. An occurrence deductible or SIR is preferred because this eliminates the catastrophic exposure potential of numerous claims arising out of a single occurrence.

In addition, aggregate protection is desired for deductibles or SIRs, limiting the number of claims or occurrences you may be responsible for in any single policy term. Expect credits for deductibles or SIRs to be greatly diminished when aggregate protection is afforded.

Last, some SIRs require the policyholder to pay allocated expenses in proportion to the amount of the indemnity claim, often calling for the payment of some allocated loss expenses above the retention level.

In our next issue, we will discuss some of the advantages and disadvantages of deductibles and SIRs, as well as some of the things to look for when considering this approach.

-- Charles H. Cox

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