What is self-insurance?
Self-insurance doesn’t mean not being insured. It’s the process of retaining predictable losses, whilst insuring unpredictable ones.
In other words, you don’t purchase insurance for the small claims with a minor financial impact. These losses will be less than an insurance premium.
You do insure for unknown claims. This ensures you retain a predictable amount of risk and insure the unpredictable ones.
So self-insuring is about setting aside a pot of money for anticipated losses rather than purchasing insurance to cover them.
What Do You Need to Do?
Doing this is fairly straight forward. Essentially, you’ll need to create a fund for losses and set a limit.
Much like an insurance premium, you set aside a limited fund to cover any potential losses in a given period (e.g. April to March).
You can do this in one of two ways
- Paying a premium to a captive insurance company; or
- Not paying an insurer and making a financial provision to cover losses.
How Do You Do It?
One of the big benefits to self-insurance is that you can insure any risk, as long as you can work out how much money to put aside (and it’s less than an equivalent insurance premium).
Some risks are very expensive or mainstream insurers won’t touch them at all - such as public liability or environmental damage.
In order to consider a risk insurable it has to be something the insurer could not have foreseen.
Acts of God, such as floods or earthquakes, are not usually something you would self-insure as it is just too unpredictable and you could potentially have huge losses.
Catastrophic risks would often be covered by captive insurance.
How Does It Work?
Being exclusively self-insured isn’t recommended for the simple reason that a combination of commercial and self-insurance provides the best cover.
This format works best because the predictable losses are retained and covered by self-insurance and forms the first layer of protection.
The second layer is a commercial insurance policy which kicks in once the loss fund limit has been reached. In this way, the first layer is, in effect, a large excess to the second layer.
As such the second layer will become less expensive as it doesn’t need to cover the smaller, more likely, risks.
Is Self-Insurance a Good Idea?
As an individual this is probably not the most cost effective solution. It’s unlikely that the cost savings will be enough to allow you to negotiate with captives or insurers.
However, if you are a commercial organisation (private or public sector) then this is likely to be an excellent way to reduce costs. Not just that,but the process of self-insuring identifies areas where you can manage your insurance more effectively.
How to Build up a Self-insurance Fund
Review and cancel insurance policies which you can afford the risk yourself.
Check the small print on all your policies for duplicate cover. You’d be surprised how often this happens.
Review your insurance program. Your insurance needs change over time, so check and make any adjustments. This ensures correct coverage and the lowest possible premiums.
Make a record of all your policies. Detail premiums paid and loss recoveries. Knowing your ‘risk profile’ can help reduce your premiums as it avoids over-insurance.
Once you have accrued a loss fund, you’ll want it to be working for you. Generally speaking, short term investments which can be easily cashed-in without financial penalties are your best bet.
Liquid mutual funds or money market funds are relatively safe investments. Steer clear of stocks and bonds though as they are too volatile.
Standard savings accounts are the safest but provide a lower return. They are also the quickest way of accessing your money.
Look out for our 'Guide to Self-Insurance'
Keep an eye out for our comprehensive ‘Guide to Self-Insurance’ we will be publishing soon. Check back or sign up for updates if you’d like to be one of the first to know.
You may also be interested in: