Most major financial transactions require what is often referred to as "skin in the game." The vast majority of mortgage loans, for example, require a specified down payment for purchases and a certain level of equity for refinances. This assures a lender that its borrowers have invested their own assets in the collateral property and, accordingly, are less likely to default on their commitment.
The same principle holds true for the insurance business. A policyholder is more inclined to care for life, health, real estate, vehicle or other personal property when a claim first requires a contribution upfront. This is known as insurance retention.
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What Is Retention In Insurance?
Insurance policies generally contain language that makes clear what fraction of a total claim the holder must pay before the insurer issues any compensation. Once this agreed-upon threshold is crossed, the insurance company then pays on the remainder of assessed damages. Like the down payment in a home purchase, the retention insurance minimizes recklessness and gives confidence to the provider.
In a strict sense, the loss retention definition could mean the holder assumes all of the risk, depending on the circumstances and contractual terms. In short, think of the verb: how much risk will the claimant retain?
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What Does Retained Limit Mean in Insurance?
Retained limit means "this far and no farther." It is that line where the claimant's financial input ends and the insurer's begins. When shopping for a policy, consumers will undoubtedly want a low retained limit whereas insurance underwriters will want to see affirmations of an applicant's good driving record, for instance, when setting the retained limit.
Property insurers observe that those with poor credit make more claims. This, too, can affect where the retained limit is set. This important figure represents the intersection of the policy holder's interests with those of the insurance company.
What Are Examples of Risk Retention?
A loss retention definition shows up most commonly in the form of deductibles. A driver is stopped at a light and is rammed by the car to the rear. The damage amounts to $3,000, so the driver puts in a claim for the repairs. The insurance company, per the agreement with the driver, will – provided the facts support the claim – pay out $3,000, requiring the customer to meet a deductible of $500.
Retention insurance here represents the driver's assumption of risk. A transfer insurance definition, in this case, is that portion of the risk absorbed by the insurer, i.e., $2,500. The deductible here is most often paid to the insurer after the claim is paid.
More Risk Retention Examples
Whereas, deductibles meet the loss retention definition post facto, re-imbursing the insurance company after a claim is paid, other examples demonstrate that retention insurance can be remunerated ahead of any action by the insurer. For example, the liability coverage in a homeowner's policy stipulates a self-insured retention (SIR) amount.
This means that, in the event of a visitor getting injured on the property, the owner is obliged to finance legal and indemnity costs out of pocket until the SIR limit is reached. Only then does the insurance provider get involved.
So if a child's friend comes over and falls down the stairs, breaking a collar bone, the owner might be obliged to pay $25,000 in lawyer fees and/or medical expenses before the insurer reviews a claim against a $200,000 liability policy.
Is Retention Amount a Dollar Figure or Percentage?
It is common to see a dollar amount in most retention clauses. However, percentages are not unheard of.
Adam Luehrs is a writer during the day and a voracious reader at night. He focuses mostly on finance writing and has a passion for real estate, credit card deals, and investing.