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A dispute can arise when the party who is expecting insurance protection first learns after a claim that the SIR needs to be fully assumed before the insurance becomes available.

Risk Management

Self-insured retention vs. deductible

Protect your clients by knowing the differences between these two mechanisms

By Donald S. Malecki, CPCU

An issue that likely will confront producers in the future is how to handle confirmation of self-insured retentions (SIR) on insurance certificates. The reason is that insurance certificates, such as ACORD 25, that are used for liability insurance do not allocate space for designating an SIR, and knowing that such an SIR exists can be important to those who should know.

An SIR often is mistakenly referred to as a deductible, particularly by some courts and members of the legal community. Briefly, an SIR represents the amount of damages and sometimes legal costs insureds must assume before liability insurance becomes payable.

An example is where the insured has a liability limit of $1 million and an SIR of $100,000, which can be depleted through a combination of damages and legal costs. Before insurance becomes payable, the insured must assume the SIR amount. In effect, after the insured assumes the SIR, it still has the $1 million limit available to pay claims and suits.

If the insured has a deductible instead of an SIR, the deductible is applied to the cost of damages, thus resulting in less insurance received than with an SIR.

Another difference between the two concerns legal costs. Some self-insured retentions encompass both damages and legal costs. In contrast, it would be the exception, rather than the rule, for a deductible to include legal costs. The insurer usually is responsible for the payment of all legal costs, and usually in addition to the policy limit.

Having pointed out these differences between an SIR and a deductible, it is important to mention why parties such as additional insureds need to know that an SIR exists. First, an SIR is commonly higher than a deductible and must be fully assumed before pure insurance becomes available.

This means that a dispute can arise when the party who is expecting insurance protection first learns after a claim that the SIR needs to be fully assumed before the insurance becomes available. What can be especially perplexing here is when the SIR has to be assumed by both the named insured and the additional insured, or when the named insured declares bankruptcy before assuming the full SIR limit.

Without clear notice of an SIR, the party who is asking for proof of insurance cannot plan for it. For example, because an SIR is not commonly viewed as insurance, an SIR should be referred to as noninsurance in any "other insurance" provision so that it can be taken into consideration when damages and/or legal costs of both parties need to be allocated.

Sometimes parties who want to be apprised of an SIR's existence also will require that the party who has the SIR post proof of financial responsibility. Unfortunately, learning for the first time after a claim arises that a large SIR is a condition precedent to the payment of insurance may generate a dispute that could end up being costly to both parties.

A case in point

A case in point is Multicare Health System d/b/a Multicare Good Samaritan Hospital v. Lexington Insurance Company, 2013 WL 4532248 (U.S. Ct. App. 9th Cir.). The hospital contracted with Medical Staffing Network (MSN) to provide the hospital with temporary nursing staff as well as professional liability insurance.

MSN gave the hospital a certificate of insurance, issued by the producer, reflecting that MSN had such insurance with limits of $5 million per act and aggregate. The certificate did not state, however, that the policy was subject to a $1 million SIR.

Sometime later, a family filed a lawsuit against the hospital and MSN alleging negligence by an MSN nurse. Through arbitration, the family was awarded $785,000 plus fees and costs. The hospital was dismissed from the lawsuit.

The next year, the family notified the hospital that MSN might not be able to pay the award and that the family intended to file a motion to vacate the order dismissing the hospital from the lawsuit. At the same time, the family notified the hospital that the MSN professional liability policy contained a $1 million SIR.

The hospital sued MSN's insurer and the producer, alleging that their failure to include the $1 million SIR on the certificate was a material misrepresentation on which the hospital relied to its detriment because it had become liable for the $785,000 malpractice award.

The court of appeals held that the insurer (1) did not make a misrepresentation to the hospital by issuing a certificate without showing the SIR; and (2) did not have a duty to disclose the SIR on the certificate, which did not contain a column for retention or deductible amounts.

Interestingly, at the time of this case, the insurance certificate required descriptions of any applicable exclusions added by endorsement. The hospital maintained that the SIR endorsement was an exclusion that should have been described in that section of the certificate. This argument, however, failed to persuade the appeals court.

Breach of contract

In the case of Cushman & Wakefield, Inc., et al. v. One Source Facility Services, Inc., 2012 WL 5950506 (Sup. Ct. App. Div.,1st Dept. N.Y.), the party who was supposed to show proof of insurance and any applicable SIR found out the meaning of breach of contact when it failed to show the SIR amount on a certificate of insurance it had issued.

Briefly, a property owner retained a contractor to perform exterior maintenance, including snow and ice removal. The contractor in turn subcontracted its snow removal duties. This case arose when an individual was injured when she slipped on black ice on the owner's premises while on her way to work.

The contract between the property owner and the maintenance contractor required the contractor to maintain a CGL policy with combined single limits of $1 million and additional insured coverage. The contract also stated that if the contractor's policy included a self-insured retention, the certificate of insurance was to so indicate and state the amount.

The contractor's policy had limits of $1.5 million per occurrence and aggregate with an additional insured endorsement and an SIR of $500,000.

Considering the reasonable expectations of the parties, the court found that the contractor breached its obligation to procure insurance that named the property owner an additional insured subject to a limit of $1 million.

Because of the SIR, the contract required the contractor to pay out $500,000 before its CGL policy provided any benefit. The court found that the property owner was entitled to damages based on the contractor's failure to procure insurance as required.

The case of Continental Casualty Insurance Co. v. Zurich American Insurance Company, et al., No. 09-35484 (U. S. Ct. App. 9th Cir. 2010), involved a coverage dispute between contractors on a construction project. At issue was which party was responsible for defense costs incurred in an injury action brought by an employee of a subcontractor against the general contractor.

The contract between the parties required the subcontractor to procure primary insurance with $1 million limits issued by an "A rated or better" insurer satisfactory to the general contractor. Under this language, the court stated that if the subcontractor had intended to self-insure in an amount equal to the dollar amount of coverage it had agreed to obtain, it should have notified the general contractor to allow the latter to decide whether the subcontractor's SIR was satisfactory.

As it turned out, the subcontractor obtained a policy with an SIR, so the subcontractor's insurer had no duty to provide a defense until the retention was exhausted (which, in this case, it never was). As a consequence, the subcontractor's insurer did not provide the general contractor with the expected primary coverage. Accordingly, the court held that the subcontractor had breached its promise to procure coverage.

Is the time ripe for change?

These are not the only cases involving self-insurance retentions and certificates. As more entities learn about these adverse court decisions, they are likely to exercise greater caution, such as requiring proof of self-insured retentions.

The time may not be ripe for certificates to include a separate category for confirming the existence of self-insured retentions. Both the ACORD 25 Certificate of Liability Insurance editions (2009/09) and (2014/01) include spaces to confirm the existence of a retention or deductible regarding umbrella and excess liability policies. These amounts, however, are usually not as large as the self-insured retention amounts maintained by entities with their primary liability coverage.

The court in the Multicare Health System case made an important statement when it said: ". . . the hospital has failed to show with clear, cogent, and convincing evidence that information about the SIR was not easily obtainable." What better way for the hospital to have done that than to request confirmation via the certificate?

For the time being, entities that enter into contracts requiring proof of insurance may want to insert a provision to the effect that any existing SIR is required to be declared on the certificate under the "Description of Operations" section.

The entities that impose this requirement may be doing producers and others a big favor because, as demonstrated, failure to follow contractual specifications can have painful consequences. This also could be the case insofar as producers are concerned, particularly when errors and omissions insurers instruct their producers not to insert anything on certificates that do not designate space for that item.

The author

Donald S. Malecki, CPCU, has spent more than 50 years in the insurance and risk management consulting business. During his career he was a supervising casualty underwriter for a large Eastern insurer, as well as a broker. He currently is a principal of Malecki Deimling Nielander & Associates LLC, an insurance, risk, and management consulting business headquartered in Erlanger, Kentucky.

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