Self insurance

by Admin
Updated: August 18, 2020

With self insurance you can benefit from investing the fund as well as saving the premiums

Insurance companies provide vital protection from financial loss. However, when you’re in a situation where your risk is exceptionally low, you might be better off paying into a fund you control instead.

The main advantages of managing your own insurance funds are:

  1. Saving the premiums
  2. Investing the fund
  3. Control over decisions

You benefit from being a careful (low risk) person, i.e. by never needing to claim more than the value of the fund.

The good, the bad, and the ugly

Small things are the easiest and most sensible to insure yourself because they represent losses that can be priced exactly and aren’t too expensive compared to normal income & expenses.

For example, if an insurance policy for an electronic device costs $10/month and you pay 3 years without a claim you’ve lost $360. If instead you insured yourself, you’d have that money in a fund and if it had been invested you could have earned money from it too.

  • If you’ve looked after your device, you’ve now have it as well as all the money that would otherwise have been spent as insurance premiums.
  • If you need to replace the device at this time, you have that option (without having to prove a loss) and you’ll be no worse off provided the replacement cost minus the insurance deductible is less than the value of the fund.
  • If the device had to be replaced early, i.e. before there was much money in the fund, it should not be a financial disaster.

Expensive incidents are less suitable for self-insurance because they can be expected to involve payouts far in excess of an individual’s total premiums

Insurance companies benefit from pooling risk so that a lifetime’s premiums will be less than an individual would otherwise have to pay privately to cover a total loss. Insuring buildings yourself, for example, rarely makes financial sense.

Enduring liability - where a single incident leads to potentially unlimited ongoing payments - are the most dangerous. Such things as personal injury insurance (health insurance) fall into this category.

Legal requirements

In certain situations, in order to make sure that someone who suffers injury or loss is sufficiently compensated, bona fide third party liability insurance may be required by law, e.g. vehicle insurance.

Stop loss insurance

Stop loss insurance is used by insurance companies to protect them from paying out to an extent that would be ruinous.

Since it is almost always possible to pay personally instead of making an insurance claim, it is possible to gain the benefits of self-insurance while treating the regular insurance as a stop loss.

In addition to accumulating a fund by not claiming, the availability of a private fund provides scope to avoid the penalties of a claim being recorded (and ruining your track record) and of premiums being increased.

As the self-managed fund grows, it becomes more feasible to obtain insurance with a larger deductible, which is cheaper. This in turn allows relatively more to be contributed to the fund.

For example, you take out an insurance policy with a $500 deductible and also start to put $42 per month into a savings account. By the end of the 1st year, you’ll have more than $500 and you can switch to a $1,000 deductible with lower premiums (your liability will still be approximately $500, i.e. the amount of the deductible minus the value of the fund).

Ideally, the value of the fund should be grown to be at least equal to amount of the deductible so that any claim will have zero impact on cash flow.

Investing the fund

Keeping a self-insurance fund separate & untouchable requires tremendous self-discipline.

It is a good idea to set the money aside in a way that it cannot be quickly withdrawn yet is accessible in reasonable time compared to credit availability, e.g. use a credit card or loan secured against the fund in the interim.

More info

Self insurance as defined in this article by investopedia.com.

“Avoiding High Insurance Costs by Self-Insuring” at thebalance.com.

“Small Businesses & Self Insurance: Not Usually a Match” at fitsmallbusiness.com.

“Stop-Loss Insurance 101: What It Is And How It’s Used” at springbuk.com.

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