Ever feel like reading your policy creates more questions than it answers? You’re not alone. Insurance is filled with jargon. While there’s good reason for your insurance policy being a 100+ page monster filled with a dizzying web of definitions and exclusions, the ‘why‘ doesn’t really matter to most people…they just want to know what’s covered. We want to help!
What’s a retention?
In insurance, the word retention is always related to how a company handles its business risk. When you ‘retain’ risk, it usually means you’re not insuring it. The common alternative would be to pay an insurance company an annual premium to take that risk off your hands.
But we’re getting more specific than that when we’re looking at the declarations page of your policy. If you have a directors & officers, errors & omissions or cyber liability policy (among many others) you’ve probably seen it, followed by a dollar amount. The carrier is specifically referring to something called a self-insured retention (SIR).
This is the amount of money that you are required to pay, per claim, before the insurance company will start paying.
The carrier is asking you to “retain” some of the risk in the form of a small amount of self-insurance. The amount they ask you to retain depends on who you are and what insurance you’re buying. A startup’s fiduciary liability policy is considered low-risk so there may only be a $1,000 (or even $0) retention for each claim. A professional liability policy for a hedge fund is considered high-risk so the retention may be as high as $250,000. Large public companies might have D&O policies with self-insured retentions of $1,000,000 or more.
Why do I have to pay a retention?
As we alluded to above, it’s partially about how much risk is at stake. But there are some less obvious reasons why you’re required to pay a retention. You might actually have a reason to be happy about it…ok so not happy per se but just hear us out.
- It’s a deterrent: a retention means you have skin in the game. If you make a mistake, you’re going to have to chip in. Insurance companies believe this promotes personal responsibility, allowing them to take on more risk from more companies.
- It’s a cost-control tool: as retentions go up, premiums go down and vice versa. This allows for tailor made pricing for companies that want to manage the amount of risk they want to keep vs what they’ll pay to push off to an insurance company.
- It makes insurance cheaper for everyone: claims are expensive. Whether or not they end up paying the claim, when you file a claim it sets off a chain of events that costs the insurance company time and money. So the retention sets the baseline for how severe a claim has to be before the carrier starts that chain of events. Without it, small “nuisance” claims would push premiums up across the industry.
Isn’t that the same thing as a deductible?
Basically? Yes. But if you really want to dig into the nitty-gritty of the differences, we recommend checking out this article from our friends at the International Risk Management Institute.
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