What Does Retention Mean in Insurance?

When reviewing your insurance policy, you may come across the term “retention” along with a dollar amount. This is an important concept to understand, as it refers to the portion of any claim you are responsible for paying before the insurance company’s coverage kicks in.

Below we’ll explain exactly what retention is, how it works with various insurance policies, and why insurers require policyholders to retain some of the risk.

Defining Retention in Insurance

In the insurance world, retention refers to the amount of money the policyholder must pay out-of-pocket for a claim before the insurer begins covering any costs. It’s similar to a deductible in that sense.

For example, if you have a business liability policy with a $5,000 retention and experience a $10,000 claim, you would be responsible for paying the first $5,000. The insurance company would then cover the remaining $5,000 in damages under your policy.

Retention goes by other names as well:

• Self-insured retention (SIR)
• Insured retention
• First-dollar retention

But they all refer to this concept of the policyholder retaining a portion of the risk by paying some of the claim costs directly before insurance kicks in.

How Retention Works in Different Insurance Policies

While retention can apply to various insurance lines, it is especially common with certain types of coverage:

Directors and Officers (D&O) Liability Insurance

Companies purchase D&O insurance to cover legal claims against their directors and officers. For a large corporation, the retention may be $500,000 or more per claim. Small businesses often have much lower retentions closer to $5,000. The retention must be paid whether the claim has merit or not.

Professional Liability Insurance

Also known as errors and omissions insurance, professionals like consultants, architects, and engineers use this coverage. Their retentions often range from $1,000 to $100,000 depending on revenue and perceived risk. The policyholder pays the retention when accusations of negligence or mistakes arise.

Cyber Liability Insurance

After data breaches and other cyber incidents, expenses add up quickly. Cyber liability policies help offset costs like IT forensics, customer notification, credit monitoring, PR, and legal defense. Retentions may be as high as $500,000 for large companies.

General Liability Insurance

Most businesses have a commercial general liability (CGL) policy covering claims of bodily injury, property damage, personal injury, and advertising injury. Typical retentions are in the range of $500 to $5,000 per occurrence.

As you can see, retention amounts vary widely based on factors like company size, industry, and perceived risk level of the insured.

Why Do Insurers Require Policyholders to Retain Risk?

There are a few key reasons why retention is standard in insurance policies:

• Lower premiums – By requiring insureds to pay some of each claim, overall rates stay affordable. Insurers can pass on savings.

• Discourage small claims – Retentions deter policyholders from filing tiny claims that cost more to process than to just pay out. This keeps administrative costs down.

• Reduce moral hazard – When policyholders retain some financial risk, they are incentivized to be careful and avoid claims. This reduces careless behavior.

• Weed out high-risk accounts – Applicants not willing to retain enough risk may be deemed too high-risk to insure profitably. Retention helps attract better risks.

• Customized coverage – Varying retention amounts allows policies to be tailored for each insured’s tolerance of risk and ability to share costs.

Retentions ultimately balance meaningful coverage with shared responsibility between policyholder and insurer. This symbiotic approach provides protection for insureds while keeping policies affordable for both parties.

How Insurers Determine Appropriate Retention Amounts

Insurers use a range of factors to set retention requirements when pricing policies:

• Industry risk – Cyber policies typically have higher retentions than general liability due to greater risks.

• Company size – Large corporations retain more risk than small businesses in absolute dollar amounts.

• Revenue – Within industries, larger companies based on sales revenue retain higher retentions.

• Loss history – Frequent past claims mean higher retentions going forward.

• Credit score – Financially stable firms retain more than economically unstable ones.

• Risk mitigation – Companies with strong internal controls and risk management retain less than poorly managed firms.

• Desired premium – Policyholders willing to retain more risk pay smaller premiums for insurance.

Agents will assess these parameters for each applicant to arrive at appropriate retentions when structuring policies. The ranges are ultimately guidelines, not hard rules.

Retention vs. Deductible in Insurance

While they may seem identical at first glance, retention and deductible are distinct concepts:

• Retention is the amount the policyholder is responsible for per claim before insurance applies.

• Deductible is the portion of each claim paid by the insurer that is reimbursed by the policyholder before coverage kicks in.

For example:

• A claim comes in for $100,000
• The retention is $5,000
• The deductible is $1,000

So the insured would pay the $5,000 retention. The insurer would then pay the full $100,000 claim upfront. But the insured needs to reimburse the $1,000 deductible back to the insurer afterwards.

While subtleties exist, both terms refer to the insured’s share of the risk. Retention is just embedded into each claim, while deductibles are collected after payment.

The Takeaway on Retention in Insurance

Retention, often called self-insured retention or SIR, is an integral part of most insurance policies. By requiring insureds to pay a set amount toward claims out of their own pocket, insurers are able to provide coverage more broadly and at more affordable rates.

Policyholders benefit from tailored retention levels matching their financial means and risk tolerance. Insurers benefit from reduced moral hazard and claim frequencies. So retention ultimately allows for win-win coverage solutions for both parties.