Large Deductible Versus Self-Insured Retention

With recent predictions that the hardening of the commercial insurance market will continue beyond 2021, corporate insurance buyers are exploring all means of mitigating the adverse impact of limited insurer capacities and escalating costs. This includes the consideration, to the extent a balance sheet may allow, to retain a larger portion of risk through the use of self-insured retentions or deductibles.

Self-insured retentions (SIR) and deductibles, although they are different, are intended to accomplish the same goals. However, the most common insurance buyers or laypersons often confuse the two concepts and commonly use the terms interchangeably. Even experienced insurance professionals and insureds are often found scratching their heads when considering which of the two concepts are a best fit or when faced with applying SIRs or deductibles to actual coverage situations. While deductibles and SIRs share common features, they are indeed separate and distinct, and their application can dramatically affect the defense and/or coverage obligations of both insureds and insurers.

A deductible or SIR dictates the monetary threshold at which an insurer is obligated to pay liabilities covered by the policy. The use of these tools enable an insurer to shift the burden to pay for a portion of the claim to the insured. Factors determining the favorability and amount of an SIR or deductible to an insured are many. However, two of the most common factors involve risk tolerance of the insured, cost savings, as well as the ability/interest in the insured to retain involvement in the handling of a claim.

As one might presume, the higher the amount of either an SIR or deductible, the upfront premium cost for a policy will be reduced. However, when selecting between the two options, there are other factors to be considered, including but not limited to the ultimate cost to the insured (when taking into account claims handling, defense, etc.). Although terms of specific policies differ and are subject to negotiation between insured and insurers, listed below are some notable pros and cons to be considered when determining the suitability of an SIR or a deductible.

Deductible Pros

• Insurer will typically front the deductible, paying the claimant in full, then bill the insured for reimbursement of the deductible amount.
• If the insured cannot pay/reimburse the deductible, the claimant is still made whole by the insurer.
• Insurer must investigate. If a claim is potentially covered, the insurer has an immediate duty to respond and defend the insured at the first dollar level.
• The insurer is fully responsible for defense costs, regardless of the amount of the deductible as long as there is a potential for coverage under the policy.
• Insolvency of the insured does not alter an insurer’s duty to defend and indemnify the insolvent insured. The insured’s insolvency will not reduce the insurer’s liability to those with insured claims.
• The insurer must defend additional insureds from the outset.
• On most general liability policies, defense costs are normally outside the limit of liability (defense costs do not erode the policy’s limit of protection). However, policy language must dictate if defense costs are allowed to erode the deductible. For large deductible, this is often a matter of negotiation with the insurer.
• Since the insurer is ultimately responsible for paying covered losses, regardless of the deductible amount, this means that a Certificate of Insurance need not divulge the fact that a deductible applies.

Deductible Cons

• After payment to a claimant, the insurer will require reimbursement of the deductible portion from the insured. Therefore, collateral is usually required (most often in the form of a Letter of Credit) to secure the insurer in case the insured cannot reimburse the insurer for the deductible.
• Requires financial statements from the insured, followed by close scrutiny by underwriters to assess the insured’s ability to assume and pay the deductible obligation.
• Insurer retains control of the defense, including choice of defense counsel.
• Unless the policy provides otherwise, the insurer is allowed to defend and settle claims made against the insured without the insured’s consent. This is true, even if the entire settlement amount falls within the deductible for which the insured is responsible.
• Deductibles typically erode the limit of liability. For example, a $1 million policy limit with a $250,000 deductible would leave $750,000 in true insurance protection.
• Worker’s compensation and, in some cases auto 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 the insured must post a self-insurer’s bond with the state.

SIR Pros

• Insured controls its own defense for all claims within the SIR, including choice of defense counsel. If the insurer wishes to do so, the insurer is free to associate its own defense counsel but only to monitor the defense.
• Collateral not required since insured is responsible for the SIR.
• Degree of premium savings are typically a bit higher with an SIR, since it saves the insurer defense costs, and it is perceived by underwriters that the insured has more skin in the game.
• Most likely, the insurer will not be permitted to question the insured’s decisions if they are made in good faith.
• Even though it may avoid exposing the insurer to liability, there is no implied duty upon the insured to accept a settlement offer within the SIR.
• SIR does not erode the limit of liability.
• SIR can offer a cash flow benefit in that the insured pays out costs as they are incurred, rather than in advance via insurance premiums.

SIR Cons

• SIRs are applicable only to policies providing liability protection, not property insurance.
• SIR is not covered by the policy. It is purely the insured’s responsibility. No fronting by the insurer.
• Insurer does not get involved until the SIR is reached, or until reserves pierce the insurer’s attachment point, or at a designated threshold at which the insurer should be notified.
• Insured is fully responsible for the administration of claims within the SIR, including provision of and payment for a defense and any other allocated loss adjustment expenses.
• Until the SIR is reached, the insurer has no obligation to either indemnify or provide or pay for the insured’s defense.
• The insured’s insolvency does not obligate an insurer to drop down to pay the SIR (absent some deficiency in policy language). An insurer will continue to have no obligation to defend or pay a claim within the SIR.
• Insurer has no obligation to defend or indemnify additional insureds until the SIR is satisfied.
• Depending on the SIR threshold, insurers typically require the insured to engage the services of a third party administrator to handle claims.
• SIRs must be divulged on Certificates of Insurance, as the insurer has no responsibility to pay claims until the SIR is exhausted. In effect, the insured is the first insurer until the SIR is reached.

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 from the ground up. 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.

Nonadmitted specialty insurers, however, are far more likely to permit SIRs. In fact, most nonadmitted insurance companies are not equipped to handle each and every claim, so an SIR suits their purposes.

Think wisely before choosing a high deductible or high SIR plan, considering the positive and negative effects on a business and insurance program. Just because your premium is lower may not mean you’ll end up paying less in the long run.