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Most people are familiar with the term “deductible” from personal insurance, which refers to the amount of money you must pay in an insurance claim before receiving coverage from your insurance company. In business insurance, deductibles are quite common, though there is another way for the insured to pay an initial fixed amount of an insurance claim through something called a Self-Insured Retention (SIR). A Self-Insured Retention is an alternative method to take on some of the risk of a liability insurance policy, while saving money at the same time. In contrast to deductibles, Self-Insured Retentions put much of the management of your claims in your own hands.
SIR Insurance policies are popular with mid- to large-sized businesses, and these policies offer additional benefits to those who can handle the extra responsibility of paying out any early costs from their own pocketbook. If you are a business that constantly deals with low-level insurance claims, a Self-Insured Retention Insurance policy may be right for you.
What is Self-Insured Retention?
Self-Insured Retention is a set amount of money in a liability insurance policy that you must cover before your insurance company begins to pay out your claims.
For example, if you are insured through a liability policy with a $1 million limit and a $100,000 SIR, you’ll need to pay for the first $100,000 of any claim before your insurer begins to cover the claim. In a deductible-based plan with a $1 million limit and $100,000 deductible, your insurance company would pay for any claims starting at the first dollar until your policy limit, and would later bill you for up to the $100,000 deductible. The concepts of an SIR and deductible are similar, but there are some key differences.
In a Self-Insured Retention Insurance Policy, not only does your business need to pay the up-front SIR in a given claim, but your business also takes over the role of managing the claim up to the SIR amount. Because the insurance company doesn’t play any role in a claim until the SIR is exhausted, the duties of managing the claim fall to the insured. In a deductible-based plan, this is different. The insurance company manages the claim from the very beginning.
With an SIR, your business sets up a fund and either outsources the work to a third-party or uses one of your own employees to manage the program. Though an SIR Insurance Policy is more labor intensive, it also offers businesses the opportunity to control the claims process and, since your company is taking on more of the insurance risk yourself, receive a lower rate on premiums. Having an SIR Insurance Plan, however, does require your business to have enough capital to fund the SIR. For this reason, a Self-Insured Retention Insurance Policy is often a better fit for mid-size or larger companies with the resources to pay out claims.
Self-Insured Retention vs Deductibles
In a deductible-based policy, the insurance company pays the full value of your claim up to your policy limit. After they have paid the bill, they will charge you for the money they spent up to the amount of your policy’s deductible.
In a Self-Insured Retention plan, you pay the initial SIR amount out-of-pocket by yourself, with no input or support from the insurance company. In fact, for a claim that is lower than the SIR amount, generally there is no need to even inform your insurance company about the claim. Once you have paid the SIR amount, your insurance company can then step in and pay for any amount above the SIR amount and under your policy’s maximum limit. Because you are the only one responsible for claims within the SIR amount, this offers your business more freedom to manage and negotiate smaller claims, without the involvement of your insurance provider.
A deductible policy works like this:
- You own a business that sells vintage typewriters, and because they are so valuable, you have a commercial property insurance policy. A fire damages your business property, and your insurance company calculates that there was $15,000 worth of property damage done to your business. Your policy has a limit of $30,000 with $5,000 deductible. The insurance company pays for the $15,000 worth of damage and later sends you a bill for the $5,000 deductible you owe them.
A Self-Insured Retention Insurance Policy works this way:
- You own a business that sells motorcycles, and because they are so dangerous, you have a general liability policy. A child starts a motorcycle in your showroom and attempts to ride it down a narrow hall. He runs over the foot of a customer in their mid-thirties, who decides to sue you for the accident. She wants $75,000 for medical expenses and lost income. You are insured for $1 million with a Self-Insured Retention of $200,000. You manage to negotiate the claim down to $60,000 with the help of your in-house lawyers. You pay her the $60,000 out of a fund you set aside for cases like these, and your insurance company has no involvement in the claim.
Benefits of Self-Insured Retention Insurance
The major benefit of Self-Insured Retention Insurance policies is lower premiums. In a deductible plan, your insurer takes on the immediate risk of paying out losses up to the limit of your policy, relying on the insured to eventually pay back the deductible. With SIR, your business is taking on the initial risk of paying out damages, which is reflected in the total cost of your insurance.
Self-Insured Retention Insurance can save you money in a variety of ways. Benefits of Self-Insured Retention Insurance include:
- No collateral requirement – when insurance companies take on large liability policies, they require collateral to prove that the insured is able to pay its deductible. Often times the collateral requirement is a multiple of your possible aggregate deductible costs for the year, which can be quite a sum. SIR does not have this requirement.
- Lower insurance premiums – you will pay lower premiums because your company is taking on the initial risk of paying claims within the SIR amount.
- Increased cash flow – your cash flow may improve because more of your capital will only be spent in the event of a claim, rather than going to the insurance company through higher premiums.
- Increases your insurance policy limit – if your policy is worth $1 million with a deductible of $50,000, you will only receive $950,000 worth of insurance coverage. When you use SIR, you get the entire $1 million value of your insurance limit.
- More control over claims adjustments – you can decide whether to settle or contest a claim. This privilege is not given to those with deductible policies, because all claims are handled by the insurance company.
- Claims not included in loss history – often times insurers will take the expedient route and pay out smaller claims rather than defend against them. Because of this, your loss history may be impacted with these smaller claims. With an SIR, you have more control and may choose to defend against smaller claims and protect your loss history. A cleaner loss history can make your business more appealing to future insurers and can earn you better rates.
In addition to saving you money with your insurance policy, SIR insurance has the added benefit of giving you additional motivation to reduce claims. When you use an SIR insurance policy, you are responsible for managing the ins and outs of each claim. Knowing more information about the causes of your claims can create a feeling of responsibility and incentive to reduce risk within your company.
Drawbacks of Self-Insured Retention Insurance
The primary drawback of Self-Insured Retention Insurance is that your business will have to dedicate time and resources to handling your insurance claims. If you are knowledgeable and experienced in the field of insurance claims or use a third-party administrator (TPA), you may be able to save money. However, if you are inexperienced in negotiating claims, you may wind up paying more than you would have with a high-deductible plan.
Who should buy Self-Insured Retention Insurance?
Self-Insured Retention Insurance is a good fit for mid- to large-sized businesses with the capital to fund an SIR and also experience a high frequency of low-cost claims. If you typically face more than 20 to 25 claims per year, your carrier may be ill-equipped to manage them effectively. If you have the resources and experience to handle these claims yourself, SIR insurance is a better fit.
If you don’t have a capable employee or outside business to handle your claims, you should choose a high-deductible policy instead of SIR insurance. Businesses with fewer than 10 people, or who have never successfully negotiated an insurance claim before, would probably do better to trust their insurance company. Before purchasing Self-Insured Retention Insurance, you should be sure that your business has at least one of the following tools:
- A risk manager – if not a risk manager, then a chief financial officer who is willing to take on the responsibility of managing the claims.
- A risk management information system – often provided by insurance companies or third-party administrators, this computer program can help you manage your claims, property values, insurance policies, and exposure information.
- A third-party administrator – if you want to buy SRI insurance, and you are inexperienced in negotiating claims, a third-party administrator can take over the task of managing claims for you. Make sure that the fees that you pay the third-party administrator don’t eclipse your savings.
If you have frequent claims, but your business does not have the resources to negotiate or manage them, you can also reduce your premiums with a higher deductible policy.
How do you set up Self-Insured Retention Insurance?
According to state law, you must set up a separate fund in an interest bearing account designed to cover your losses. Depending on whether you decide to adjust your claims, you can also hire a third party to do this for you.
The amount of money you must pay out-of-pocket before your insurance kicks in is referred to as your retention rate. If you set your retention rate too high, you might be forced to pay more than your business can afford. Conversely, setting the rate too low will cause your insurer to step in and pay out claims too frequently. This can cause a loss for the insurance company and lead to a poor claims history for your business.
Self-Insured Retention Insurance is a promising alternative for mid- to large-sized companies that want to save on insurance premiums and get more value out of their insurance limit. By taking on the role of managing any smaller claims before their insurance policy coverage kicks in, companies can take an active role in managing the risks of their business.