Deductibles vs self-insured retentions: who pays first

With a deductible, the insurer handles the claim from the first dollar, pays it, and then bills you for the deductible amount or takes it out of a settlement. With a self-insured retention (SIR), the policy does not respond until you have paid the retention yourself, and you generally run the claim inside that layer. Both mean you carry the first slice of a loss. They differ in who controls the claim, whether your limits shrink, and what happens if you cannot pay.

How each one works

The last three rows draw on the comparison in IRMI's commentary on retentions versus deductibles, and the details always come down to the endorsement wording. A common ISO endorsement, CG 03 00 (Deductible Liability Insurance), adds a deductible to the general liability form for bodily injury and property damage damages. Its wording lets the insurer pay any part of the deductible to settle a claim and requires the named insured to reimburse it promptly. One older edition reduced the each-occurrence limit by the deductible but not the aggregate, so read your edition. SIRs are usually written by a manuscript or carrier-specific endorsement, and carriers differ.

Where you will see each

Small and midsize businesses meet deductibles nearly everywhere: property, commercial auto physical damage, equipment breakdown, and the occasional per-claim liability deductible. Percentage deductibles for wind, hail, earthquake and flood are a type of deductible too (named storm deductibles: how percentage wind deductibles work). Business income coverage has a time deductible, the 72-hour waiting period in the standard CP 00 30 form.

SIRs are the norm in these places:

• Umbrella and excess liability, where a retention applies when the underlying policy does not cover a claim (umbrella vs excess liability).
• Professional liability, D&O, cyber and other claims-made lines, where the market usually says "retention" and means an amount you pay first, with defense costs typically counting toward it.
• Larger primary liability programs and surplus lines placements.

Workers' compensation has its own version, the large deductible program, where the insurer pays claims and bills you back, and the carrier requires collateral (large deductible workers' comp programs: how they work and what they cost). Employers that go further self-insure with state approval (self-insuring workers' comp: requirements and trade-offs).

Control of the claim

This is the difference that surprises people. In a deductible program the insurer owns the file. It picks defense counsel and, unless the policy says otherwise, can settle without your consent even if the whole settlement falls inside your deductible. Say a customer claims $18,000 in property damage and the insurer decides settling is cheaper than defending. You owe the $18,000 either way, and you had no vote.

Under an SIR you choose counsel and decide whether to fight or settle, until the retention is spent. That is an advantage for a company with a risk manager and a view about precedent or reputation. It is a burden for one with no one to manage claims, because you have to investigate, pay, track and document each claim, and the insurer will want the file once the claim might reach its layer.

Notice still matters. Most SIR endorsements require you to report a claim to the insurer even if you expect it to settle inside the retention, often once it reaches some portion of the retention or involves a serious injury. Skipping that step and watching a claim grow beyond your estimate is a common route to a late-notice dispute (notice of claim and late notice: why timing matters).

What counts toward the retention

This question has produced litigation. Policies often say the retention must be paid "by the insured," and parties then fight over whether payments by someone else count: a subcontractor's insurer, a co-insurer, an indemnitor or an additional insured. Courts reach different results depending on the policy language and the state.

• The Florida Supreme Court held in Intervest Construction of Jax, Inc. v. General Fidelity Insurance Co. (Feb. 6, 2014) that, absent clear policy language to the contrary, payments by a third party can satisfy a retention that must be "paid by the insured" (Jones Day's summary).
• A California appellate court held in Forecast Homes, Inc. v. Steadfast Insurance Co. that only the named insured, not an additional insured, could satisfy the SIR in that policy (Construction Defect Journal).

Some carriers have since tightened endorsements to say the named insured must pay from its own funds as a condition of coverage. If you are an additional insured under someone's SIR policy, or you expect a subcontractor's money to count, get it in writing before you rely on it. Insolvency makes this worse: a policyholder that cannot pay its retention may leave the claimant, and an additional insured, without a responding policy.

A worked break-even (hypothetical)

Say a distributor is offered a $12,000 premium credit for moving its property and liability deductible from $5,000 to $25,000. Its loss runs: what they are and how to request them for the last five years show six claims above $5,000: $6,000, $9,000, $12,000, $14,000, $20,000 and $60,000. The extra amount it would have kept under the higher deductible, claim by claim, is $1,000, $4,000, $7,000, $9,000, $15,000 and $20,000 (the last capped at the $25,000 deductible less the old $5,000). That totals $56,000, or $11,200 a year.

The credit of $12,000 beats the average by only $800 a year, and in exchange the distributor takes a bumpier cash flow, a worse year if two mid-sized claims hit together, and a claim count it is guessing at. At a $30,000 credit the trade would pay for itself comfortably; at $6,000 it would not. The deductible and retention break-even calculator runs this arithmetic with your own claims history. Five years is a thin sample, so a broker will usually also look at industry loss patterns before recommending a change.

Questions to ask before choosing

1. Can we absorb the worst year? Add up what the retention would cost if it were hit several times, not once.
2. Who pays defense, and does it erode the retention? Compare with defense costs inside vs outside policy limits: why it matters.
3. Does the retention erode the limit? If your contract requires $1 million of coverage, check that you still have that much after the deductible or retention.
4. Do any contracts cap the amount? Many leases and customer contracts limit deductibles or SIRs, or require approval above a stated dollar amount (how to review the insurance requirements in a contract).
5. Is collateral required? A letter of credit ties up borrowing capacity.
6. Can we handle claims? If you choose an SIR, who investigates, who pays vendors, and who reports to the insurer?
7. Does it fit the bigger plan? Higher retentions are one tool in risk transfer vs retention: avoid, reduce, transfer or retain, and above a certain size a captive may be worth studying (what is a captive insurance company and how does it work?).

Key takeaways

• A deductible is billed back after the insurer pays and gives the insurer control; an SIR must be paid first by you, and you usually control the claim until it is spent.
• A deductible often reduces your limit and an SIR usually does not; confirm the wording of your edition and endorsement.
• Report claims to the insurer even when you expect them to stay inside the retention.
• Courts split on whether other people's payments satisfy an SIR, so get the answer in writing.
• Compare a premium credit with your own five-year loss history before raising a retention, and check any contract that limits what you can retain.