Application of self-insured retentions (“SIRs”) is the frequent topic of court decisions around the country. These insurance provisions are so common because they are effective. They give the insured a stake in the liability, and consequently, provide him incentive to avoid losses in the future. Scott C. Turner, Insurance Coverage of Construction Disputes, § 4:6 (2008). Nonetheless, when several policies with multiple SIRs are involved in a continuous loss case, courts often experience tension balancing the constructs of interpreting policy provisions according to their plain meaning and advancing the reasonable expectations of the parties.
A self-insured retention or “SIR” is an amount that must be paid before the insurer
has any duties under the policy. Vons Cos., Inc. v. United States Fire Ins. Co., 78 Cal. App. 4th 52, 63-64 (Cal. Ct. App. 2d 2000); General Star Indemnity Co. v. Sup. Ct., 47 Cal. App. 4th 1586, 1594 (Cal. Ct. App. 2d 1996). See also Scott C. Turner, Insurance Coverage of Construction Disputes, § 4:6 (2008) (discussing SIRs).
The language of the SIR controls how it may be satisfied. Some provisions require the insured to pay the retention out of his own pocket. See Vons Cos., 78 Cal. App. 4th at 63 n.4 (quoting a SIR stating “[i]n the event there is any other insurance, whether or not collectible, applicable to an ‘occurrence’, claim or suit within the Retention Amount, you will continue to be responsible for the full Retention Amount before the Limits of Insurance under this policy apply”). Some are silent on the issue. However, in the absence of contrary policy language, any money source, including a contractor’s other insurers or jointly and severally liable co-defendant’s carriers, may satisfy a SIR. Id. at 63-64.
In recent years, another issue has cropped up concerning the application of SIR funds. The debate no longer centers around what type of funds are used or from what source they stem – the debate is now whether defense costs count as funds that may be used to satisfy the SIR as opposed to solely indemnity payments (i.e., settlement or judgment payments). In most SIR provisions, defense costs, included within the definition of “loss adjustment expenses,” are amounts that deplete the retention.
A primary reason why contractors obtain primary policies with SIRs is to achieve a predictable level of loss. For example, if a subcontractor purchased a policy with a $25,000 SIR, he could rest easy that if a claim arose, he would have to come up with $25,000, but anything above this amount would be fully-covered by the carrier. If the law construed SIR policies as only taking effect when an indemnity payment was due, this interest of loss predictability would be lost. Depending on the claim, defense costs could be $5,000 or $500,000, and the SIR policy would lose its true value.
Additionally, most SIR carriers themselves include express wording in SIRs stating that defense costs decrease the retention amount. They do this because they also want to keep tabs on the risks of a claim. If only indemnity costs depleted SIRs, a SIR carrier could be faced with the situation of having to pay the majority of an unreasonable settlement brought about by unnecessary and costly legal work. Therefore, most SIR carriers would be in favor of law interpreting defense costs as reducing the applicable retention amount.