Self-Insured Retention (SIR) is the amount a business must pay out of pocket before its insurance coverage begins. It is the portion of a loss that a business must pay out of pocket before its insurance coverage takes effect.
This is different from a deductible, as the self-insured retention applies to all claims, and the business retains the financial responsibility until the loss exceeds that specified amount.
SIR is often used in liability insurance policies where higher limits of coverage are desired at a lower premium cost.
Businesses opt for self-insured retention when they believe that they can handle the smaller losses internally, reducing their insurance costs while still providing coverage against significant claims.
This strategy can help businesses manage their cash flow and insurance expenses effectively.
In addition to reducing premium costs, implementing a self-insured retention can also encourage businesses to maintain a proactive approach to risk management.
Companies often work to minimize their claims frequency and severity, as they have a vested interest in protecting their finances up to the SIR limit.
This can lead to better practices and controls in areas such as safety, compliance, and operational efficiencies.
Examples
A manufacturing company has a self-insured retention of $100,000. If they face a liability claim that costs $150,000, the company is responsible for the first $100,000, while their insurance policy covers the remaining $50,000.
A technology firm decides to implement a self-insured retention of $50,000 on their professional liability insurance. When they are sued for services rendered, the first $50,000 of legal and settlement costs must be borne by the company, with their insurer covering expenses beyond that threshold.
Key Features of Self Insured Retentions
Cost Savings: By opting for a self-insured retention, businesses can lower their insurance premiums.
Increased Control: Businesses have more control over their claims process and risk management strategies.
Financial Risk: Businesses must be prepared to cover the SIR amount, which can be a significant financial burden.
Potential for Increased Claims: If businesses do not manage risks effectively, they may face more claims that they must cover before insurance applies.
When SIR Might Be Advantageous
Here’s when an SIR might be a better choice over traditional insurance with a deductible:
- Businesses with Strong Cash Flow & Risk Management
- Companies that can comfortably cover claims up to the SIR threshold without financial strain.
- If a business has a strong risk management program, it can reduce claim frequency and severity, making an SIR structure more cost-effective.
- Industries with Predictable Claims Patterns
- Businesses in industries like manufacturing, healthcare, and construction, where claim patterns are well understood, can use SIR to control costs rather than pay higher premiums.
- If a company has a high frequency of low-severity claims, it may benefit from handling those internally and using insurance only for catastrophic events.
- Desire for Greater Control Over Claims Management
- With an SIR, businesses handle their own claims (or outsource to a third-party administrator), allowing them to control legal strategy, settlements, and claim payouts.
- This prevents insurance companies from quickly settling claims just to avoid litigation, which can sometimes lead to unnecessary increases in future premiums.
- Lower Premiums in the Long Run
- Since the insurer only pays after the SIR is met, businesses often enjoy significantly lower premiums.
- If claims are minimal, businesses can save money compared to traditional insurance.
- Avoiding Collateral Requirements Associated with Large Deductibles
- Insurers often require businesses with large deductibles to post collateral (e.g., letters of credit) to guarantee payments, whereas an SIR typically does not have this requirement.
- This frees up capital for other business needs.
- Businesses with High-Risk Tolerance & Legal Expertise
- Companies with in-house legal teams or experience in handling claims efficiently can reduce external legal expenses.
- If a company frequently litigates and wins claims, an SIR allows them to manage their legal strategy rather than relying on the insurer’s appointed defense.
When SIR Might Not Be Ideal
- If cash reserves are low – An SIR means covering claims out of pocket up to a high threshold.
- If claims frequency is unpredictable – Businesses in high-risk industries with uncertain claims exposure might struggle with unexpected claim spikes.
- If internal claims management is weak – Mishandling claims can result in higher costs or even a failure to trigger policy coverage.
SIR: Did you know?
A surprising or little-known aspect of Self-Insured Retention is that it often requires the insured company to handle its own defense costs and claims administration until the SIR limit is met.
Unlike a deductible, where the insurance company usually handles claims from the start and simply requires reimbursement from the policyholder, an SIR shifts the responsibility of managing claims, hiring lawyers, and negotiating settlements to the insured business.
This means that companies using an SIR must have the financial and operational capacity to effectively manage these aspects, along with hidden administrative costs and legal complexities.
Some policies with SIR provisions may not even trigger coverage until the insured formally acknowledges the claim and meets all reporting obligations. This can create unexpected financial exposure if businesses fail to properly track and report claims, leading to denied coverage later on.
Category: Business Risk Management
References and further reading about Self-Insured Retention: