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Deductible vs Retention vs Coinsurance: What You Need to Know

Navigating insurance can be complex, but the concepts are easy to understand when broken down. When it comes to insurance coverage, three key concepts that often confuse are deductibles, retentions, and coinsurance.

Below, we will provide you with a comprehensive overview of these concepts, highlighting their similarities, differences and practical implications of each.

What is a deductible?

A deductible describes the amount of money that an insured party is responsible for before their insurance coverage kicks in. It is essentially a threshold that needs to be met before the insurance company starts paying for any covered expenses. The ultimate purpose of a deductible is to share the financial responsibility between the insured individual and the insurance provider.

When you purchase an insurance policy with a deductible, you are essentially agreeing to bear a portion of the risk associated with potential losses or damages. The deductible amount is typically specified in the policy itself and can vary depending on the type of coverage and the insurance company.

Sometimes, a deductible may apply and the insurer has already began payment of the claim (ie to a third party due to a liability claim). In this case, the insurer will collect from the insured.

The deductible acts kind of like a form of self-insurance, requiring you to cover a portion of the cost before the insurance company steps in. In many cases, it also allows an insurance company to avoid paying small, attritional losses that will be the responsibility of the insured.

What is a self-insured retention?

A retention (ie self-insured retention or “SIR”) is where the policyholder takes on a certain amount of risk and financial responsibility before the insurance coverage begins to pay for a loss.

With an SIR, the insured party agrees to pay for a predetermined amount for claims out of their own funds before the insurance company becomes liable for coverage. SIR can be a useful tool to allow businesses to have more control over their insurance costs and claims management.

Unlike a traditional deductible, which is usually a fixed amount per occurrence, an SIR is often an aggregate amount that applies to a policy period. Once the SIR is exhausted, the insurance coverage kicks in, and the insurance company becomes responsible for any additional losses or claims, subject to the policy terms and conditions.

Why insurers impose deductibles and self-insured retentions

There are a number of reasons why insurance companies impose one or the other.

Encourages responsible risk management

By imposing deductibles and SIRs, insurers incentivise their policyholders to take steps to mitigate their risks, as they become financially accountable for a portion of losses.

This encourages insureds to implement safety measures, invest in preventive measures and engage in risk-reducing practices – ultimately fostering a culture of responsible risk management.

Balances the financial burden between the insured and the insurer

Deductibles and SIRs ensure that policyholders bear a portion of the financial responsibility for covered losses. This balance of financial burden aligns the interests of the insured and the insurer, preventing “moral hazard” situations where the insured party may otherwise be tempted to file frequent or inflated claims without considering the financial implications.

Helps prevent excessive or unnecessary claims

Deductibles and SIRs serve as deterrents against the submission of small or trivial claims. Insured policyholders are more likely to refrain from filing claims for minor damages or losses that fall below the deductible or self-insured retention amount, reducing administrative costs and streamlining the claims process for more substantial and impactful events.

Promotes cost control and affordability of insurance coverage

Insurers can offer more affordable premiums by imposing SIRs and deductibles. This is because the sharing of risk and costs between the insured and the insurer ensures that insurance coverage remains accessible and sustainable for everyone, striking a balance between protecting against major losses while maintaining reasonable premium levels.

Deductible vs self insured retention: What is the difference?

At face value, they look more or less like the same thing. However, a key difference is that deductibles  lower the level of insurance available and while SIRs usually don’t – the full level of insurance is available once the SIR amount is exceeded. For example:

  • Deductible: a policy with a $20,000,000 limit and a $200,000 deductible only provides $19,800,000 of insurance.
  • SIR: a policy with a $2,000,000 limit and a $200,000 self-insured retention provides a full $2,000,000 of coverage, but only after all covered claims on a combined basis exceeds an amount of $200,000.

This is the basic concept, but we’ll break down a number of key differences between deductibles and self-insured retention.

Responsibilities of an insurer when loss occurs

Under an SIR, the insurer most of the time has nothing to do with the losses that do not exceed the certain SIR amount. An insurer may require notification when the claim becomes close to reaching the end of the SIR amount, but that’s really the end of the matter.

With a deductible, the insurer pays every cent of the loss (up to the maximum policy limit) and is then reimbursed by the deductible.

Requirements for collateral

Insurance companies may require collateral when they assume risk, meaning that if the insured party is unable to pay a loss, the insurer becomes responsible for covering the loss.

In situations involving self-insured retentions (SIRs), the insurer has no obligation to pay any losses until the SIR is fully exhausted, and therefore, there is no collateral requirement.

On the other hand, larger deductibles often require the insured to provide collateral, such as a letter of credit or another acceptable form, to cover anticipated losses within the deductible amount.

What is co-insurance?

Co-insurance is a term used in insurance to describe the sharing of costs between the insurance company and the insured party after a deductible has been met. It is a financial arrangement where both parties contribute a percentage of the covered expenses.

In a co-insurance arrangement, the insured is responsible for paying a specified percentage of the costs, while the insurance company covers the remaining percentage. For example, if the insurance policy has a 20% co-insurance requirement, the insured would be responsible for paying 20% of the covered expenses, and the insurance company would pay the remaining 80%.

Deductible vs Retention vs Coinsurance: What is right for my business?

Understanding the different implications of deductibles, retentions, and coinsurance is crucial when selecting insurance coverage for your business needs. Each concept has its own unique characteristics and can significantly impact your financial responsibility and the scope of coverage provided by the insurance company.

If you find yourself unsure about which option is best suited for your specific situation, it is highly recommended to seek expert advice.

Our team of experienced insurance professionals here at Axxima are ready to assist you in making informed decisions regarding your insurance. We understand that every business has unique requirements, and we can help tailor an insurance policy that aligns with your risk tolerance, budget, and coverage needs.

Whether you require guidance on selecting an appropriate deductible, evaluating the advantages of a retention, or understanding the implications of coinsurance, our team is here to provide the expertise and support you need.

You can get in touch with our insurance experts right here.