Self-insured retention (SIR) is a self-insurance mechanism used by some organizations to manage their insurance costs. Under a liability insurance policy with a SIR provision, the business must cover a set dollar amount before the insurance company begins to pay out claims. SIRs allow businesses to retain or manage more risk since they are responsible for handling and paying claims as long as the claim is below the dollar amount specified in the policy.
This article examines SIRs, how they differ from deductibles, and the pros and cons of these provisions.
How SIRs Work
A business with a SIR provision must pay their up-front SIR costs and manage the claim up to the SIR amount, effectively reducing premiums and the number of claims they take to their insurer. However, since the insurance company doesn’t become involved until the SIR limit is met, managing the claim falls on the insured.
How Do SIR Provisions Differ From Deductible-based Coverage?
SIR provisions are an alternative to deductible-based coverage and allow businesses to take on some of the risks of a liability insurance policy. While deductible-based coverage and SIR provisions are similar conceptually—both are used to keep premiums down and require the insured to pay for a portion of the loss—there are some key differences businesses should be aware of, including:
- Insurer responsibilities in the event of a loss—Under a SIR provision, the insured must pay the initial amount out-of-pocket with no input or support from the insurer. Some insurance companies may require notice when a claim has occurred, even if it’s lower than the attachment point. With deductible-based coverage, the insurer pays losses up to the maximum limit of liability and is then reimbursed by the insured up to the deductible amount.
- Collateral requirements—In situations where the insured cannot pay a loss, the insurer may be obligated to step in and pay. The insurer has no responsibility to pay with a SIR provision until the SIR is exhausted, meaning there is no collateral requirement. Conversely, deductible-based coverage usually requires a letter of credit or other collateral to cover any losses within the deductible.
- Defense costs—With small deductibles (less than $100,000), the costs to defend claims are typically included as supplementary payments that don’t erode the policy limit. With large deductibles, defense costs usually do erode the deductible, but it’s subject to negotiation. Under a SIR provision, the amount is not eroded, and the insured must pay all defense and/or indemnity expenses associated with a defense until the loss exceeds the SIR.
- Limits erosion—The annual aggregate limit under a SIR provision is usually not affected by the SIR amount. For example, if the aggregate SIR is $1 million and the total policy limits amount to $10 million, the insured would have $10 million of coverage excess of $1 million SIR. With deductible-based coverage, the annual aggregate limit is usually eroded by the deductible amount. In the same scenario, the limit of liability would be $10 million, but the available insurance coverage would be $9 million, with the insured covering the initial $1 million.
The Pros and Cons of SIR
SIRs can save businesses money in a variety of ways, and the benefits of obtaining this type of coverage include:
- No collateral requirement—Collateral requirements can be substantial, often multiple of the possible aggregate deductible cost for the year. With a SIR provision, no collateral is required.
- Lower insurance premiums—Since the company takes on the initial risk of paying claims within the SIR amount, premiums are often lower.
- Increased cash flow—Businesses may experience increased cash flow since capital is being spent in the event of a claim rather than going toward higher premiums with the insurance company.
- Increased insurance policy limit—Since SIRs don’t typically erode the annual aggregate limit, businesses can utilize the entire value of the insurance limit.
- More control over claims adjustments—Businesses can decide whether to settle or contest claims that fall below the SIR amount.
- Fewer claims not included in loss history—Insurers often pay out smaller claims with deductible-based coverage, so a business’s loss history may be impacted. SIRs allow businesses to control which claims they defend, resulting in a cleaner loss history that may earn better rates from future insurers.
SIRs aren’t without their disadvantages, however, and businesses should consider the following drawbacks before choosing this type of provision:
- Increased management responsibility—The primary drawback to a SIR provision is that businesses must dedicate time and resources to handling claims.
- Increased financial responsibility—The insured’s responsibility is to cover the SIR amount and the insurer doesn’t get involved until the SIR is reached.
Overall, businesses need to consider the pros and cons of SIR provisions before choosing which type of coverage to purchase within their liability insurance policy. For more coverage guidance, contact us today.
