Retention
In insurance, "retention" refers to the portion of a claim that the insured party must pay out of pocket before their insurance coverage kicks in. It is essentially the risk that a business chooses to retain, rather than transferring it to the insurance company.
What is Retention in Insurance?
Retention in insurance is the amount of loss or damage that a policyholder agrees to bear themselves before their insurance coverage begins to pay. This concept is similar to a deductible but is often used in commercial insurance policies and can sometimes have a different structure or application.
For example, if a business has a retention of $10,000 on its insurance policy and it experiences a loss that costs $50,000, the business must pay the first $10,000. The insurance company would then cover the remaining $40,000, provided the claim is within the policy limits and terms.
Retention is a critical aspect of risk management for businesses. By choosing a retention amount, a company balances the costs of its insurance premiums with its willingness and ability to absorb smaller or more frequent losses. Higher retention usually means lower insurance premiums, as the insured is assuming more risk.
Key Components of Retention
There are three key components to understanding retention in insurance:
1. Retention Amount
The retention amount is the specific sum that the policyholder agrees to pay out of pocket before the insurance policy provides coverage. This can be a fixed dollar amount or a percentage of the loss.
2. Retention Layer
The retention layer refers to the financial range within which the policyholder is responsible for covering losses. This layer sits below the insurance company’s layer, which starts to provide coverage once the retention amount has been exceeded.
3. Aggregate Retention
Aggregate retention is the total amount that the insured party will pay out of pocket for all claims within a specified period, usually a policy year. Once the aggregate retention limit is reached, the insurer may start covering claims in full, without further retention payments from the insured.
Types of Retention Covered
Retention can come in different forms depending on the nature and structure of the insurance policy. Here are four types of retention commonly used in business insurance:
Self-Insured Retention (SIR)
This type of retention is the amount a business must pay before the insurance policy begins to respond. An SIR can be quite high and is typically used by larger companies that can afford to handle significant claims independently before seeking insurance coverage.
Deductible
Although sometimes used interchangeably with retention, a deductible is a specific amount subtracted from the payout of a claim. Unlike SIR, the insurer handles the claim from the start but deducts the deductible amount from the claim payment.
Excess Insurance Retention
Excess insurance policies provide coverage above the limits of an underlying primary policy. The retention in this case refers to the amount not covered by the primary insurance that must be met before the excess policy pays out.
Stop-Loss Retention
This type of retention is commonly used in health insurance. It limits the amount a business has to pay for claims, either on a per-claim basis or in total over a policy period. Once the stop-loss threshold is met, the insurer covers further claims.
How Insurance Covers Retention
Insurance covers retention by providing financial protection for claims that exceed the retained amount. Here’s how it works:
Claim Handling When a loss occurs, the policyholder initially covers the retention amount. The insurer then handles the claim, including investigation, adjustment, and settlement, once the retention threshold is met.
Coverage Beyond Retention Once the retention amount is paid by the policyholder, the insurance policy kicks in to cover the remaining costs of the claim, up to the policy limits. This coverage can include property damage, liability, legal fees, and other insured losses.
Policy Limits and Terms The insurance policy will specify the terms under which it covers claims beyond the retention amount. This includes the types of losses covered, exclusions, and any conditions that must be met for the policy to respond.
Premium Adjustments The amount of retention chosen by a business affects the insurance premium. Higher retention typically results in lower premiums because the insured assumes more risk. Conversely, lower retention usually leads to higher premiums as the insurer bears a greater portion of the risk.
