What Is an Application of Retention?

An application of retention is a contractual clause included in many insurance policies. The purpose of the clause is to specify what portion of any potential damages will need to be paid for by the policyholder. Damages in excess of this retained portion would then be covered by the insurance policy.

For instance, if a car insurance policy has a $1,000 deductible and a loss is valued at $2,500, then the application of retention for that policy would clarify that the policyholder is responsible for payment of the $1,000 deductible. The insurer’s liability would thus be limited to $1,500.

Key Takeaways

  • An application of retention is a declaration commonly included in insurance contracts.
  • It specifies what portion of any potential claims would be covered by the policyholder and the insurance company, respectively.
  • “Retention” and “deductible” are similar concepts, but they have distinct meanings.

How Applications of Retention Work

Applications of retention are an important part of insurance contracts because they clarify what percentage of a claim is attributable to either party. If a policyholder fails to carefully review the application of retention, they may accidentally expose themselves to more risk than they anticipated.

For instance, in the above example, a driver who purchases car insurance may fail to realize that they are responsible for a $1,000 deductible. If they are in an accident and have failed to set aside sufficient funds, they could be forced to take out loans to pay for the deductible. In extreme cases, a policyholder may even be forced into bankruptcy.

In some cases, the insurer may agree to pay for the retention in the form of a loan, such as the $1,000 deductible in this example. In that scenario, the policyholder would agree to pay back the funds within a specified period of time and would likely need to pay interest to the insurer. Typically, however, the insurance company would be under no obligation to provide this loan, making it necessary for policyholders to save ahead of time or secure other sources of financing.

Some policies, such as directors and officers liability insurance for corporations, may treat retention differently in the case that the company is in bankruptcy proceedings. If a company is bankrupt, it is less likely to be able to provide self-insurance coverage for the amount of loss that it is supposed to retain.

As a result, the insurer may be held responsible for the amount of the retention. For this type of coverage to be extended to the insured company, the language of the policy would have to contain a specific provision indicating that losses are to be treated differently during bankruptcy.

Real-World Example of an Application of Retention

It is important to note that, although the terms “retention” and “deductible” are often used interchangeably, they are in fact two separate concepts. To illustrate, consider the case of a policyholder who files a claim under their health insurance policy after visiting a doctor. 

Technically, the full amount paid upfront for the service is considered the retention, whereas the policyholder reimburses the insurance company for the deductible. The exact breakdown of what portion of the visit is covered by the insurance company, as opposed to being the responsibility of the policyholder, would be set out in the insurance policy’s application of retention.