Policyholder Pulse
General and products liability policies are a cornerstone of risk management for businesses, providing protection against alleged liability because of bodily injury, property damage, and personal or advertising injury claims. These policies are often paired with self-insured retentions (SIRs). Although some policies with SIRs may provide “first dollar” coverage, particularly for defense costs, an SIR typically represents the amount of covered loss a company agrees to pay out of pocket before the primary layer insurer’s coverage attaches. While common, SIRs can introduce many traps for the unwary—especially if the SIR is applied on a “per-occurrence” basis (or, in some policies, a “per-claim” basis) without an aggregate cap.
Death by a Thousand Cuts: The Accumulation Problem
An uncapped “per-occurrence” SIR may require the policyholder to pay up to the full amount of the SIR for each and every separate “occurrence” that arises. This raises an important question: How many “occurrences” are at issue? If all claims arise from one occurrence, the policyholder must pay only one SIR before recovering from its insurers. But if multiple occurrences exist, then the number of potentially applicable SIRs multiplies by the number of occurrences. The cumulative effect of claims arising from separate occurrences can be extremely expensive if there is no aggregate limit on the policyholder’s self-insured losses.
For example, imagine a company with a $500,000 per-occurrence SIR and no aggregate cap. If that company experiences 500 claims that are held to arise out of separate occurrences, each settling for less than $500,000, the policyholder could be forced to pay up to $250 million without the insurer ever paying a dime. That uninsured exposure could increase dramatically if the SIR is indemnity only, and defense costs do not erode the SIR, as often is the case. This defeats one of the core purposes of insurance: risk transfer to the insurer.
While companies with historically large losses involving a high number of individual claimants (e.g., pharmaceutical companies) have been dealing with these issues for decades, this accumulation risk may not be known to newer companies or even older companies that have never been involved in mass tort litigation. But this risk is not limited to situations involving mass torts. Disputes with insurers on these issues can, instead, arise in single plaintiff cases where, for example, a contractor installs hundreds of allegedly defective products in a residential tower or commercial building.
The bottom line is this: Any company with an uncapped SIR should carefully consider and plan for the potential for accumulation risk.
Potential for Uncertain Outcomes and Insurer Disputes
The risk presented by an uncapped SIR is compounded by the inherently fact-intensive nature of disputes about the number of occurrences and frequently uncertain law. Generally speaking, some states determine the number of occurrences by assessing whether the underlying claims arise from a similar common cause, while other states focus on whether the effects of the insured’s allegedly injurious acts or omissions were temporally and geographically disparate. But even states that adhere to similar tests may apply their own precedents differently, just as the factual allegations of each case can lead to different outcomes. What’s more, even determining which state’s law will govern the analysis may not be straightforward because liability policies insure multistate risks and typically lack choice of law provisions.
Potential for Coverage Gaps
The potential for disputes about how and when an SIR is exhausted can, further, open the door to other coverage disputes.
One set of potential disputes relates to which party must pay the qualifying costs and whether such amounts may be insured by a different insurer. There is no single rule in this regard, but most courts that have addressed this issue have held that payments by insurers or third parties (either directly or indirectly) qualify unless the policy clearly and unambiguously requires otherwise. For example, in Intervest Const. of Jax, Inc. v. Gen. Fidelity Ins. Co., the Florida Supreme Court held that amounts recovered from an indemnitee apply when the SIR does not specifically require the insured to satisfy the SIR from its own funds. However, since some SIRs expressly require that the amounts retained remain “uninsured,” this can be an issue.
As another example, if an insured delays reporting claims that appear to fall below the SIR threshold but later escalate, the insurer may argue that late notice bars coverage. While late-notice defenses can be navigable depending on the applicable facts and law, they increase litigation costs at minimum.
Another frequently disputed set of issues relates to how much of a company’s expenditures count toward exhaustion of the SIR. For example, if a policyholder has been defending claims within the SIR using counsel of its own choosing, the insurer may argue that a significant percentage of the defense costs paid were not “reasonable and necessary” and, therefore, allegedly cannot be applied against the SIR.
To mitigate the potential for these unexpected complications, policyholders should be careful to report and manage all claims proactively, even those unlikely to exceed the SIR, and also carefully check on any potential limitations related to how and with what types of expenses an SIR can be exhausted.
Alternatives and Risk Mitigation Strategies
Companies with high claim frequency should carefully evaluate alternatives to a per-occurrence, no-aggregate SIR structure. Options may include:
- Avoiding per-occurrence or per-claim SIRs, which will result in more up-front costs from higher insurance premiums, but will also avoid the budgeting uncertainties, litigation risk, and potentially more significant costs of requiring the policyholder to pay a full SIR for each applicable occurrence. This may not be a possibility for many policyholders, as insurers may not be willing to quote a policy that does not have a substantial SIR.
- Securing an aggregate SIR cap so that the insurer’s coverage obligations kick in as soon as the policyholder reaches a maximum limit of self-insured losses, no matter how many occurrences are found to exist. For example, if a $100,000 per-occurrence SIR is subject to a $1 million aggregate limit for defense costs and damages, the policyholder cannot be required to self-insure more than $1 million for that policy year and can avoid potentially messy disputes about whether and when the insurer’s coverage applies.
- Including a “deemer” clause that pre-defines how claim scenarios will be aggregated and deemed to constitute a single occurrence. Such a clause could say, for example, that all claims arising out of a single product lot or line will be deemed to be a single occurrence.
- Purchasing a separate, stand-alone program that is specifically designed to act as a “stop-loss” or offer protection against accumulation risk. This is often accomplished by purchasing Bermuda Form policies that were specifically developed in the 1980s for companies that were no longer able to secure traditional per-occurrence coverage for large products and environmental losses. However, these programs are not “plug and play” solutions, and properly integrating them into an existing and historic per-occurrence program requires careful consideration.
- Captive insurance structures in which the company creates its own insurer may allow the company to pool smaller claims more efficiently while the captive insurer secures reinsurance or Bermuda Form coverage for larger losses involving accumulation risk.
Conclusion
At first glance, a per-occurrence self-insured retention without an aggregate cap may appear to be an efficient way to reduce insurance premiums. But this approach can introduce significant uncertainty and financial risk, particularly for businesses with a lurking accumulation risk. If a policyholder ends up responsible for paying multiple per-occurrence SIRs, the per-occurrence/no aggregate SIR strategy could expose the business to greater peril than protection.