Self-Insured Retentions and Deductibles
When insurance costs began to escalate in the 1980’s many companies successfully turned to self-insured retention, or SIR, as a means of controlling their defense, trials and settlements and reducing broker’s commissions, premiums, and administrative costs. An SIR puts the company back in the “driver’s seat” otherwise occupied by an insurer with somewhat different interests. Utilizing an SIR has other important financial and legal implications.
Although the terms “SIR” and “deductible” both refer to the dollar amount of a loss that is borne by the insured, these terms differ in important ways. An SIR places responsibility for losses up to a specified amount upon the insured with a traditional insurance policy covering losses above that amount. A deductible is a specific sum that is typically subtracted from an insurer’s obligations under a triggered policy. Although seemingly minor, this distinction can have significant legal impact.
The existence of an SIR may effect whether and when a primary policy is triggered. It will shape the extent and nature of an insured’s obligations prior to the activation of a primary or excess policy. In the event an insured becomes insolvent and cannot pay the SIR, the issue of whether and when any of the insured’s primary and excess policies must defend and indemnify will arise.
Another important difference between an SIR and a deductible is that, depending on the terms of a traditional policy, a deductible is usually applied only to a judgment or settlement. A self-insured retention frequently includes and is eroded by defense costs. Under a traditional policy an insured tenders claims to its insurer from the outset, often having thereafter only minimal involvement. It is not unheard of for an insured to have no knowledge of the ultimate outcome of a lawsuit other than in the form of a subsequent increased premium after a deposition appearance months or years earlier. In an SIR scenario, the self-insured is actively engaged in the investigation and handling of the claim and in a position to avoid or minimize exposure. A business looking to assure product integrity and maintain control over the defense inevitably begins to gravitate toward an SIR.
An SIR is generally incorporated into primary and excess insurance policies. While a primary insurance policy may provide immediate coverage for a loss giving rise to potential liability, excess insurance only provides coverage after the primary policy limits are exhausted. The primary policy typically requires the insurer to defend and indemnify the insured. Depending on the terms of the primary policy, its limits may or may not be exhausted by defense costs or exhausted only by judgments or settlements alone. The provision for defense costs can have significant implications in mass tort cases, e.g., asbestos or water contamination cases, where the litigation may drag on for years and defense costs can be as or more potentially devastating than an adverse verdict. The ideal scenario for an insured is where the primary policy accepts the defense, and under the policy terms, the defense costs do not erode and can not exhaust the policy limits.
While a primary insurer usually has the duty to defend the insured from the time the claim is tendered, an excess insurer generally does not. The excess insurer usually has no duty to participate in the insured’s defense or contribute to a judgment or settlement until the primary coverage has been exhausted. An excess insurer’s exposure is typically limited to the policy amounts of its layer of coverage.
Understanding the important substantive and procedural differences between an SIR and a deductible as well as the difference between primary and excess insurance policies helps a business to accurately assess risk of loss and response and to make informed insurance coverage decisions.