Self-Insure: What It Is, When to Consider It, and Its Pros and Cons

Self-insurance is a financial approach that allows individuals and businesses to take control of their risk management. In this comprehensive guide, we will explore the concept of self-insurance, discuss when it is practical, and outline its advantages and disadvantages. We’ll also provide real-world examples to illustrate the concept and help you make informed financial decisions.

Self-insurance, at its core, is a risk management technique. It involves setting aside a pool of money to cover potential unexpected losses. While it’s theoretically possible to self-insure against any type of damage, in practice, most people choose to purchase insurance from third-party providers to safeguard themselves against significant and infrequent losses.

The decision to self-insure or purchase insurance from a third party often comes down to predictability and scale. The more predictable and smaller the potential loss, the more likely it is that an individual or business will choose to self-insure. For instance, some tenants opt for self-insurance instead of purchasing renter’s insurance to protect their assets in a rental property.

If you have no debt and substantial assets, self-insuring for life insurance can be a consideration. Insurance companies aim to profit by charging premiums that exceed expected losses, so a self-insured person may save money by directly setting aside funds that would have otherwise been paid as insurance premiums. However, it’s crucial to accumulate enough funds to cover yourself, your family, and your assets in the event of an accident or natural catastrophe.

Imagine the owners of a building situated on a hill adjacent to a floodplain. They decide against paying costly annual premiums for flood insurance and choose to set aside money for potential flood damage. In this relatively unlikely event, if floodwaters rise high enough to damage their building, they are responsible for paying out-of-pocket for repairs caused by the natural disaster.

In another scenario, a small business with two employees may choose self-insurance over paying health insurance premiums for them. This self-insurance plan typically takes the form of a trust. Instead of an insurance company managing investments and returns from premiums, the employer assumes responsibility for these tasks.

Self-insurance is practical when the potential loss is predictable, manageable, and can be funded without causing financial strain. It’s often used for small-scale, frequent losses.

While some individuals or businesses choose to self-insure for health, it can be risky due to the unpredictable nature of healthcare costs. It’s more common for life, property, or liability insurance.

Most states mandate certain types of insurance, such as auto insurance. It’s essential to understand and comply with your local legal requirements.