Lawyers and business people often use the terms self-insured retention (“SIR”) and deductible interchangeably, but there are important differences. When a policy has a deductible, the insurer is obligated to defend and indemnify on a first-dollar basis. The amount of the deductible is then reimbursed by the policyholder at the end of the claim. In contrast, when a policy has an SIR, the insurer typically is not obligated to pay any defense or indemnity costs until the SIR is exhausted. The policy essentially sits as excess coverage on top of a primary layer of self insurance, and the policyholder’s payment of the SIR does not reduce the policy limits.
To give an example, take a policy with a $1 million limit and a $50,000 deductible. In a scenario where the defense costs are $100,000, and the case is settled for $1 million, the insurer would pay all of the defense costs and pay $1 million to settle the case. The insurer would then seek reimbursement from the policyholder of the $50,000 deductible, meaning that it effectively pays $950,000 to settle the claim. If the policy had a $50,000 SIR rather than a $50,000 deductible, the insurer would not respond until the policyholder paid $50,000 in defense costs, and then would pay $1 million total for defense and indemnity costs, assuming defense costs erode the retention and the limit.
Although SIR provisions differ from policy to policy, typically defense costs erode the limits of the policy, whereas policies with deductibles almost always provide defense payments outside of limits. This is a significant advantage of policies with deductibles. In situations involving policies containing an SIR and eroding limits (called “wasting” policies), defense costs can quickly eat away at the available insurance, and can leave a policyholder with little coverage left to settle the case. The policy is structured that way to encourage plaintiffs to settle early, before the defendant’s attorneys’ fees erode away the policy limits.
SIRs require a policyholder to self insure the first layer of risk. This can be a benefit to policyholders who wish to handle small claims in-house. It also gives companies greater control over the handling of claims, since the policyholder can conduct an initial claim investigation, hire counsel, and decide whether to settle claims within the retention. It also reduces premium cost and can improve a company’s claims experience, since small claims will not trigger the policy. However, an SIR carries its own costs and responsibilities, as the policyholder will need experienced staff who can assess and handle claims, or will need to hire a third-party claims administrator to help handle claims.
The differences between deductibles and SIRs often are critical when dealing with additional insured coverage issues. If a policy has a deductible, a company enjoying additional insured rights knows that it will be protected even if the named insured cannot reimburse the deductible at the end of the claim. On the other hand, if the policy has an SIR, the named insured must pay the SIR before the insurance company must provide coverage. Many policies further specify that the SIR must be paid by the named insured and cannot be satisfied by the additional insured. In the event that the named insured cannot pay the SIR, the additional insured may not be able to trigger coverage under the policy. It is therefore important for insurance requirements language to specify whether a deductible or SIR may be used, how high the SIR may be, and that the additional insured can satisfy the SIR itself to trigger the coverage.