Self-insurance is a strategy for managing risk where a person or business reserves a certain amount of money to cover unexpected losses. In theory, you can self-insure for any kind of damage, such as from floods or fires. However, in reality, most individuals opt to buy insurance to protect themselves from large, rare losses.
Learn more about Self-Insure
Self-insuring against certain risks can often be more cost-effective than purchasing insurance from an external provider. When losses are smaller and more predictable, individuals or businesses are more inclined to opt for self-insurance. For instance, some renters choose to self-insure instead of buying renter’s insurance to safeguard their belongings.
The rationale behind this is that insurance companies typically charge premiums that exceed the anticipated losses to ensure profitability. Therefore, a person who self-insures can potentially save money by reserving the funds that would have gone toward insurance premiums. However, it’s essential to accumulate and set aside sufficient funds to protect yourself, your family, and your belongings in the event of an accident or natural disaster.
Example
Building owners located on a hill near a floodplain might decide not to invest in expensive annual flood insurance premiums. Instead, they could allocate funds for potential repairs in the unlikely event that floodwaters rise enough to cause damage. In such a scenario, the owners would need to cover the repair costs themselves due to the natural disaster.
In a similar vein, a small business with just two employees might choose not to pay for their health insurance premiums. Instead, the business could self-insure, often setting up a trust for this purpose. This means that rather than relying on an insurance company to handle the investments and returns from premiums, the employer takes on that responsibility directly.
Pros and Cons
When someone opts to self-insure, they face the possibility of not having sufficient funds to cover damages or medical expenses. Experts advise maintaining some form of auto insurance, even in states like Virginia and New Hampshire where it isn’t mandatory, as well as having homeowners insurance and health insurance for you and your family.
In certain states, you can choose to carry a bond instead of auto insurance, but you remain financially liable if you’re involved in an accident, especially if you’re deemed at fault. Having insurance acts as a safety net for you, your belongings, and your loved ones. While self-insuring might save you money in the long run, it requires a strong commitment to saving enough to shield yourself from unexpected events like fires, floods, accidents, and even death.
Initially, the Affordable Care Act (ACA) imposed penalties on individuals and small businesses that lacked insurance. Reports suggest this may have contributed to a rise in self-insured businesses. Major insurance companies have also started to provide alternative funding options for coverage. For instance, one plan includes back-up insurance to mitigate losses from claims. As of the 2019 plan year, individuals without health insurance are no longer required to pay a “shared responsibility payment.”
Conclusion
Self-insurance is a method where individuals or companies allocate money to manage potential risks rather than opting for conventional insurance policies. This approach can provide advantages like saving money, increased flexibility, and greater control over finances. However, it demands a strong sense of financial discipline and meticulous risk management. It’s particularly suitable for those who have sufficient resources to deal with unforeseen costs and a solid grasp of their risk levels. For others, a mixed strategy that combines self-insurance with traditional insurance might be more effective. In the end, self-insurance can serve as a valuable financial strategy when executed carefully, in line with long-term objectives and risk appetite.