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Newsletter -
Summer 2007
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Attorneys practicing in the insurance coverage arena have inevitably been faced with insurance policies that contain self-insured retentions (“SIRs”) or deductibles. The two concepts are often confused and/or use the terms interchangeably. Deductibles and SIRs, however, are separate and distinct and their application can dramatically affect the defense and/or coverage obligations of both insureds and insurers.
Incorrect application of these two ideas can result in an insured paying part or all of a defense or settlement when, in fact, correct application would obligate an insurer to shoulder all of the defense and settlement costs. The correct application of these two concepts is particularly important when the underlying claimants and/or the insured demand that the insurer tender its full policy limits in an attempt to effectuate settlement. Although their proper application is governed by the terms and conditions of the insurance policy, insurance practitioners must nevertheless understand SIRs and deductibles so as to ensure their proper application. The primary differences between SIRs and deductibles and the application of these two distinct risk retention devices can lead to very different results.
Many businesses choose to manage a portion of their risk of liability through deductibles and SIRs which, in effect, place responsibility for losses up to a specific amount on the insured. This self-assumption of a portion of the risk is often utilized by companies to reduce insurance costs. Although the concepts differ, deductibles and SIRs represent the insured’s obligation to contribute toward covered claims.
The key distinguishing feature of a deductible is that it is payable by the insured at the end of the claim rather than at the beginning. Consequently, an insured who has obtained a policy with a deductible, as opposed to an SIR, has “first dollar coverage”. That is, the insurer is obligated to pay defense costs of a potentially covered claim from the beginning and the amount of the deductible will be assessed only after the claim is resolved. By contrast, SIRs generally obligate the insured to pay the first dollars expended in a claim. Many SIR provisions provide that the SIR can be satisfied through payment of claims (settlement or judgment) or defense costs. Thus, in a typical situation where defense costs are included within the SIR, the insured is obligated to satisfy the SIR through the payment of the earliest attorney fees and expert costs and, once the SIR has been satisfied, the insurer will assume the defense of the case and pay defense costs above the SIR. In addition, in policies containing SIRs, insureds may assume responsibility and control of claims handling until the claim exceeds the retained limit. By contrast, insurers assume the responsibility and control of claims handling for policies containing deductibles.
Another important distinction between deductibles and SIRs involves the effect upon policy limits. When an insured has purchased a policy containing a deductible, the amount of the deductible is frequently subtracted from the policy limits, thereby reducing the amount of available insurance. By contrast, in a policy subject to an SIR, the insurer’s full policy limits will likely be available to respond to a loss after the SIR has been satisfied. The distinction between these two concepts is particularly important in situations where the insured is unable to pay the deductible or SIR due to lack of resources or bankruptcy. In situations involving deductibles, the insurer is liable to pay the entire covered loss up to its full policy limit and is then left in the position of having to seek reimbursement of the deductible amount from the insured. In situations involving SIRs, however, the insurer is only obligated to pay the amount in excess of the SIR. The insurer is not obligated to pay the amount retained by the insured.
Attorneys practicing in the insurance coverage arena must be cognizant of the distinctions between deductibles and SIRs, the proper application of these two concepts and the effects they have on the rights and obligations of insureds and insurers. As demonstrated above, the two concepts are separate and distinct and their applications can and do affect both the defense and coverage obligations owed by the parties to an insurance policy both in the short term and in the long term. In considering the proper application of deductibles and SIRs, insurance practitioners should be mindful of the following three questions: (1) what amounts are the insured and/or insurer obligated to pay; (2) when are the payments due (i.e., at settlement or later); and, (3) are there remaining policy limits after settlement has been completed? The deductible and SIR provisions in the policy should be carefully examined when answering these questions as the terms and conditions of such provisions will ultimately govern their proper application.
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