In this second post in the series, I hope to shed some light on the difference between an insurance policy with a deductible compared to one with a self insured retention ("SIR") and how that impacts business contracts.
I have often heard people ask what is the difference in an SIR versus a deductible. Confusion on this topic can have real-world impact when it comes to obtaining coverage under commercial contracts.
In Part 1, we discussed that bargaining for additional insured status may not always be equal to a stand-alone insurance policy. Let's presume that a business bargained for additional insured status on a CGL or other liability policy. The business then assumed it has coverage to defend and indemnify it against third-party tort claims, as if it had purchased its own insurance. However, if the liability policy is subject to a SIR rather than a traditional deductible, then the business will not obtain any coverage until the SIR is satisfied. Further, the law is unsettled (depending on jurisdiction) as to whether only the primary named insured is permitted to satisfy the SIR or whether an additional insured can make a voluntary payment to satisfy the SIR, thus obtaining the coverage it (believed) it bargained for in an indemnity agreement or commercial contract.
Deductibles and SIRs are often conflated; the differences are poorly understood by those outside of the insurance industry as well as the practical implications. Two policies can have a $1 million limit, with the only difference between the two policies being that one has a $100,000 deductible and the other a $100,000 SIR. Under an SIR policy, the $1 million of insurance only becomes payable after the $100,000 SIR is exhausted by the insured. In contrast, the deductible policy will typically immediately respond. Also, depending on the terms, the typical SIR policy will entrust the direction of the defense, appointment of counsel, and payment of legal defense costs with the insured, while the insurer typically retains control of directing the defense, appointing counsel, and paying defense costs under a deductible policy.
These simple distinctions have stark real-world implications.
First, under an SIR policy, no insurance coverage is required to respond until after the policyholder pays the full amount of the SIR. If the policyholder has cash constraints, is undercapitalized, or enters bankruptcy, it may not be able to ever exhaust the SIR (and thus there will be no requirement of the insurer to ever provide coverage to the policyholder or to any additional insureds).
Second, under a deductible policy, a policyholder is entitled to a defense (i.e., the insurer paying for an attorney and expert witnesses) as an additional insured. Similarly, the insurer immediately has a duty to defend. However, under most SIR policies, the insurer is not obligated to provide a defense and the insured(s) have to pay their own defense costs (which includes attorney's fees, expert witness fees, and other defense costs). Any business which has defended many lawsuits will know that the dollar value of defense costs can be significant and can, in many cases, exceed the costs to settle the lawsuit. The duty to defend typically does not arise under an SIR policy until after the SIR has been exhausted.
Third, as an additional insured under an SIR policy, your business's ability to obtain insurance coverage is predicated on the primary insured being able to pay the SIR. Even though you bargained to be an additional insured under the SIR, your business will receive no coverage until the SIR is satisfied. But wait . . . what if you volunteer to pay the SIR on behalf of the primary insured and thus trigger coverage? This offer of voluntary payment may not be enough; there is at least one case which prohibits the additional insured from satisfying the SIR in order to obtain additional insured coverage for itself.
Fourth, SIRs can change the way the total tower of insurance is calculated. For example, a $1 million policy with a $100,000 deductible actually provides only $900,000 of indemnity from the insurer; the policyholder pays $100,000 and the insurance company pays $900,000. However, a policy with $1 million in limits, subject to a $100,000 SIR, will often be written so that it provides for an insurance tower of $1,100,000; after the policyholder pays the first $100,000, the insurance policy is triggered and provides an additional $1 million for a total of $1,100,000. If there is an excess policy sitting above in a tower of insurance, this difference can change when the excess policy has to respond.
Without notice that a policy contains an SIR rather than a deductible, and without understanding the implications of each, a business cannot accurately plan for a loss situation. Further, the difference between a deductible policy and an SIR policy often has major implications for the defense of any claims, as the deductible policy typically places the insurer in control of the claims, hiring of counsel, and management of defense of any lawsuits.