Payments from primary insurance carriers rarely cover the entire cost of a claim. They are not intended to. So where does the rest of the coverage come from? This is where three key concepts converge: deductibles, coinsurance, and retentions.
Deductibles and coinsurance: Good, as far as they go
A deductible – money an insured party is responsible for before their insurance coverage kicks in – is the threshold amount that causes the insured party to share the financial responsibility with the insurance provider. Without deductibles, people might lack the incentives to take basic precautions against insured events.
Co-insurance, then, is the cost sharing arrangement that kicks in once the deductible has been met. The insured party is still responsible for paying a specified percentage of the costs, while the insurance company covers the remainder. For example, if the policy has a 20% co-insurance requirement, the insured would be responsible for paying 20% of the covered claim, and the insurance company would pay the remaining 80%.
What is a self insured retention?
But what about the third leg of the coverage stool? A self insured retention, or SIR, is the degree of risk and financial responsibility the policyholder retains before the insurance coverage begins to pay for a loss.
With a SIR, the insured party agrees to pay for a predetermined amount for claims out of their own funds before the insurance company becomes liable for coverage.
If this sounds a lot like a deductible, that is because a SIR functions in much the same way. A deductible, though, is a fixed amount per occurrence, while a SIR is an aggregate amount that applies to a policy period.
By having a SIR in place, an insured business could lower its premiums without sacrificing coverage and thus gain greater control over its insurance costs and claims management.
Why insurers require SIRs
By imposing SIRs, insurers incentivise their policyholders to take steps to mitigate their risks as they become financially accountable for a portion of losses. This is essentially the same reasoning noted above that causes insurers to impose deductibles.
For that matter, both SIRs and deductibles serve to balance the financial burden between the insured and the insurer. By aligning the interests of these two counterparties, these balancing mechanisms aim to prevent “moral hazard” situations in which the insured party may otherwise be tempted to file frequent or inflated claims without considering the financial implications.
Insurance companies want to mitigate big, catastrophic claims, of course, but they also have a vested interest in clamping down on a flurry of small, nuisance claims which, in the aggregate, can dramatically raise administrative costs and complexity. Thus, insurers might require a clearly delineated self insured retention amount.
In short, then, a business that wants to lower its insurance premiums but is disinclined to raise its deductible, might be well-served by agreeing to a SIR.
Understanding the different implications of deductibles, coinsurance and retentions is crucial when selecting insurance coverage for your business needs. You might want to gather professional advice.