The Corridor Self-Insured Retention

The corridor self-insured retention (SIR) is a little-used yet potentially valuable tool in the spectrum of alternative risk transfer (ART) techniques. Before we get into the various ART applications, we'll define the term and discuss its early uses.

A corridor SIR, also known as a "bikini deductible," (for reasons that will become clear in a moment), is a self-insured layer, separating the primary layer of risk—whether insured, self-insured, or funded in a captive—from the layer immediately excess of the primary. It was first used, and continues to be used, in health insurance, inserting a deductible (a real deductible, not an SIR) between a first-dollar insured health plan and major medical coverage, which is excess of the primary health insurance policy. The structure resembles a bikini because there's defined protection on the bottom and on the top—but nothing in the middle.

Corridor SIRs migrated from health insurance to property and casualty applications when risk managers, brokers, and creative excess insurance underwriters were looking for more sophisticated methods of allocating and funding risk. Typically, the corridor SIR layer is unfunded. It's used to lower the cost of (or provide access to) excess or umbrella insurance, while relieving the insured from the requirement to fund for expected losses. It is also used in structured insurance arrangements, which we'll discuss a little later.

Corridor SIRs can be designed to cover non-aggregated per-occurrence limits or a combination of per-occurrence and aggregate limits. A typical corridor SIR will include per-occurrence limits perhaps subject to an annual aggregate, depending on the risk and the excess insurance pricing. So why would you want to employ such a strategy? Much depends on how the primary layer is financed and the upper and lower attachment points of the corridor.

For example, assume you're an asbestos removal contractor, and you have to prove to a school district that you have $20 million of liability insurance limits. You've successfully negotiated a premium that reflects a $25,000 SIR on the primary $5 million (per occurrence and aggregate) insured layer, but purchasing $14 million of annual aggregate limits excess of the $5 million primary is prohibitively expensive, and few insurers are willing to provide the capacity so close to the working (primary) layer.

Your broker suggests that you consider a corridor SIR between the primary layer and the excess $14 million layer. After negotiating with the excess insurer, here is what you do. The corridor SIR is $1 million per occurrence with a $10 million annual aggregate. This arrangement accomplishes a couple of things. First, it reduces the cost of the excess $14 million layer significantly, and second, it allows you to comply with the requirement to carry $20 million of insurance.

Now, the corridor SIR must be divulged on the certificate of insurance provided to the school district, because, like any SIR, neither the primary nor the excess insurer is responsible for claims that fall within it, unlike a standard deductible. However, based on the strength of your balance sheet, and your ability to demonstrate to the school district that losses historically falling within the corridor SIR are few and far between, you are able to convince them to accept the insurance arrangements.

Structured Insurance

The best example of a creative use of a corridor SIR is within a structured insurance arrangement. Structured insurance arrangements are very similar to the old finite risk reinsurance programs, but with a credible amount of actual risk transfer. In a typical structured deal, the primary layer aggregate limits and the premium for the excess risk transfer are funded in full at the beginning of the policy term. The risk transfer layer(s) may be attached directly excess of the primary layer, or in excess of a corridor SIR. As usual, a simple example will illustrate the structure.

Structured Insurance Illustration

Let's break this down and see what's going on here. The primary aggregate limit of $10 million is funded with Rock Solid Insurance Company into an experience account, subject to a $250,000 SIR and a $1 million per occurrence limit; this is Coverage A.

The corridor SIR in excess of the primary structure is unfunded, and serves to further insulate Rock Solid from becoming involved in a claim. Once the $10 million experience account and the $20 corridor SIR are exhausted, Rock Solid will provide risk transfer of $10 million excess of $30 million. Rock Solid is charging a premium of $800,000 for this $10 million risk transfer limit.

The $10 million aggregate primary limit, also known as the notional experience account balance (NEAB), will pay claims until it is exhausted, subject to the SIR and per occurrence limits. The corridor SIR will respond identical to the primary limits. Rock Solid's underwriting requirements for this particular risk permitted it to provide $10 million of risk transfer excess of a minimum of $30 million.

If the insured commutes the policy to Rock Solid after the policy term, whatever remains of the NEAB will be returned to the insured, assuming there are no open claims, and the insured releases Rock Solid from any future liability.

So, what has been accomplished through the use of a corridor SIR in this example? First, the insured was relieved of having to fund the full $30 million of underlying limits required by Rock Solid. Second, for a relatively inexpensive premium of $800,000, the insured was able to purchase $10 million of risk transfer.