How It Works and When It Makes Sense: Self-Insurance
Self-Insurance: What it is, How it Works, Example
What Is Self-Insurance?
Self-insurance involves setting aside your own money to pay for a possible loss instead of purchasing insurance and expecting an insurance company to reimburse you. With self-insurance, you pay for a cost such as a medical procedure, water damage, theft, or a fender bender out of your own pocket rather than filing a claim under your policy with an insurance company.
Key Takeaways
- Self-insurance is a strategy for mitigating against the possibility of a future loss by putting aside a set portion of your own money, rather than buying insurance and having an insurance company reimburse you for what you’ve spent.
- Anything from a health care cost to property damage to a fender bender can potentially be covered by self-insurance, vs. filing a claim under a policy with an insurer.
- For charges that are likely to be minimal, self-insurance be a good bet, as it may end up costing the individual less than paying for monthly or annual insurance premiums.
- Self-insurance may also be appealing to those who believe it worthwhile to avoid paying high premiums to insure against the possibility of a potentially expensive, but unlikely to occur event.
- The risk, or biggest disadvantage of self-insurance, is if an event occurs that is costlier than what the self-insured person was anticipating, potentially causing financial stress or devastation.
Understanding Self-Insurance
Insurance is designed to protect against financial losses you can’t afford to bear, but for losses that you can afford, self-insurance can save money since you aren’t paying insurance premiums. When considering self-insurance, you’re weighing the certainty of spending money on premiums against the possibility of incurring a loss that you won’t be able to turn to insurance to pay for.
You probably already self-insure for certain items without even realizing it. When you choose your deductible on an insurance policy, you’re basically self-insuring for the amount of the deductible. You’re choosing an amount of risk you’re comfortable paying for out of pocket, such as $1,000 or $5,000. Another area where people frequently self-insure is when they reject extended warranties. While a warranty is not technically insurance, it is similar in that it covers the cost of an adverse event. However, because most people can afford to replace or repair items like televisions and computers, they forego extended warranties and self-insure instead.
Special Considerations
For very expensive risks, self-insurance only makes sense if you’re wealthy. For example, few people choose to self-insure their homes. For one, if you have a mortgage, your lender will require you to carry homeowners insurance. But even if your house is paid off, you probably don’t want the risk of having to pay out of pocket to completely rebuild it if it burns to the ground. If your net worth is high relative to the value of your house and you aren’t terribly risk-averse, however, it might make more sense to forego purchasing insurance, save the few hundred dollars it would cost you every year, and keep money set aside in the unlikely event that you need to rebuild.
If you’re going to self-insure, it is important to have an accurate understanding of the worst-case scenario so you’re prepared financially. As an alternative, if the risk is too high, you might consider maintaining insurance but with a very high deductible.
Self-Insurance Example: U.S. Health Insurance
In the United States, self-insurance applies especially to health insurance and may involve, for example, an employer providing certain benefits—like health benefits or disability benefits—to employees and funding claims from a specified pool of assets rather than through an insurance company. In self-funded health care, the employer ultimately retains the full risk of paying claims, whereas when using insurance, all risk is transferred to the insurer.
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