Self-Insured Retention

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21 Aug, 2024

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Self-insured retention is an insurance type in which the policyholder or insured is responsible for paying a specified amount towards a loss before the insurance company becomes responsible for the remaining amount. Once the retention limit is reached, the insurer will typically take over and cover the remaining amount of the loss up to the policy limits.

It is a self-insurance mechanism often used by organizations. The primary advantage of this provision is that it allows the insured to handle claims themselves before the insurer initially takes over and exempts them from regular premium payments. Retention is commonly used in commercial insurance policies such as liability and workers' compensation, but it is important to note that retention is not the same as a deductible.

What Is Self-Insured Retention?

The self-insured retention is an insurance policy type in which the policyholder accepts responsibility for paying a specified amount of losses from their pocket before the insurance coverage begins.
Organizations can use it as a risk management tool to reduce the cost of insurance premiums. Still, it also requires sufficient financial resources to cover potential losses.
They are customizable and tailored to the policyholder's specific needs, allowing them more control over their insurance program.

How Does Self-Insured Retention Work?

Self-insured retention is an insurance policy in which the insured party agrees to pay a specified amount of losses out of pocket before the insurance company begins to pay. This means that the insured party essentially acts as their insurer for a portion of the risk, with the insurance company only becoming liable for losses exceeding the retention limit.

The history of self-insured retention can be traced back to the early 20th century when large companies began to use it to manage their insurance costs. In the United States, the 1970s saw a rise in the popularity of retentions as companies sought to reduce their reliance on commercial insurers and better manage their risk exposure. Today, retentions are commonly used in various industries, including construction, healthcare, and transportation.

One of the main advantages of self-insured retention is that it allows the insured party to have more control over their insurance costs. Assuming a portion of the risk, the insured party can often negotiate lower premiums with their insurance company. Additionally, retentions can provide more flexibility in terms of coverage, as the insured party can tailor their policy to meet their specific needs.

However, one of the disadvantages of retentions is that they require the insured party to have the financial resources to cover losses up to the retention amount. This can be a significant burden for some companies, particularly smaller ones. Additionally, retentions can be more complex than traditional insurance policies, requiring more resources and expertise.

Examples

Consider the following examples to understand the concept better.

Example #1

George takes a self-insured retention endorsement on his auto insurance policy with a limit of $2000. A year later, George crashes his car into a store, and the repair expenses cost $2500. At the time of the accident, the retention held by George was $1400. With a retention policy, George will be required to pay the retention amount of $1400, and his insurer will pay the balance of $1100 towards the repair expenses.

Example #2

Here's news regarding the securities litigation in a special purpose acquisition company (SPAC). This area is known for the exorbitantly high number of cases. Due to this, the Directors and Officers' (D&O) liability insurance is usually very expensive. Even the cost of self-insured retention and deductibles is very high (in the millions). For insureds with traditional D&O coverages, the retention costs $5 to $20 million on de-SPAC transactions depending upon the risk.

Self-Insured Retention vs Deductible

Let's distinguish between self-insured retention and a deductible:

An insurance deductible is a sum the insured has to pay as part of the claim. Therefore, the claim amount will be paid by the insured and the insurer (after the deductible). On the other hand, suppose there is an insurance claim; the insurer will handle the claim amount directly and demand reimbursement from the insured.
For example, if an insured has a $500 deductible on their policy and incurs $700 due to an accident. The insured will have to pay $500, and the insurer will pay the rest.
Retention and deductibles look like similar concepts considering that the insurer has to incur some expenses upfront. Another similarity is that the premiums on these two provisions are also generally lower.
One of the differences is that until the retention limit is reached, the insured doesn't have to approach or report any contingencies that might have occurred to the insurer. Therefore, the number of claims won't matter until then. However, deductibles don't work like that. Any contingencies must be reported to the insurer, who will evaluate the claim amount. Therefore, retention gives more control to the insured than the insurance deductible.
In a retention policy, the claims are settled by the insured (in most cases). Contrarily, in insurance deductibles, first, the insurer steps in and is later compensated by the insured.
And for this purpose, insurance deductibles often require collateral while retention does not.

Frequently Asked Questions

When is self-insured retention applied in an umbrella policy?

A self-insured retention may be applied in an umbrella policy when the primary policy's limits have been exhausted. The self-insured retention is essentially a deductible that the insured must pay before the umbrella policy kicks in to provide additional coverage.

What is a corridor self-insured retention?

A corridor self-insured retention is a type of insurance policy combining elements of self-insured retention and traditional insurance. In this policy, the policyholder retains a certain amount of risk through self-insured retention. Furthermore, a "corridor" of traditional insurance coverage also kicks in once the retention limit has been reached.

What is the difference between self-insured retention and captive retention?

Self-insured retention and captive retention are both risk retention methods used in insurance. The key difference between the two is that self-insured retention involves the insured party retaining a portion of the risk and paying for claims up to a certain amount. In contrast, captive retention involves setting up a captive insurance company to assume and manage the retained risk on behalf of the insured party.