What is self-insurance?

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Although purchasing insurance policies is often seen as the traditional way to obtain coverage, there is another option: self-insurance. Self-insurance involves setting money aside to pay for potential losses rather than paying insurance premiums in exchange for coverage. Although it is a less popular method of insurance, it may be a good option for some situations. In fact, tens of thousands of businesses self-insured their employee health benefits in 2018.

While a self-insurance plan may be appealing, it presents a very specific set of risks and potential advantages to individuals. Should you consider forgoing a traditional insurance policy and instead set aside money to pay for the unexpected? Here, we define self-insurance and explore the pros and cons to help you decide.

What is self-insurance?

When you choose to self-insure, you set aside money to cover the unexpected instead of reaching out to an insurance company to purchase a traditional policy.

The primary perk of self-insuring is that while you are disaster-free, you get to pocket the money you would have paid in insurance premiums. The major drawback, though, is that when you do face an unexpected loss, the full burden of financially recovering from it falls to you.

Self-insurance and the policy types it can replace

Self-insurance can apply to various types of insurance. If you are wondering where you might be able to implement self-insurance in your own life, below are some policy types that self-insurance can replace.

Car insurance

While most states require that drivers carry at least certain minimum levels of liability insurance from an insurance company, you may be able to explore self-insurance for other components of your car insurance coverage.

For example, if you are concerned about monthly expenses, you could choose to get your liability coverage through a cheap insurance company and self-insure for other protections, like collision and comprehensive coverage. You could set aside money to repair or replace your vehicle if it is damaged. This would mean that, while you have a traditional insurance policy for your liability coverage, you would be self-insuring for the damages to your own vehicle.

This may not be an option for you if you have a loan or lease on your vehicle, as your lender will likely require that you carry full coverage car insurance. It could also be relatively expensive to repair or replace your car, so you may want to compare the level of savings you would need to what you would pay for a traditional car insurance policy in your state.

Homeowners and renters insurance

If you have a mortgage, your lender most likely requires you to carry homeowners insurance. But if you own your home outright, you may be interested in establishing a self-insurance plan.

This option works best if you already have a significant amount in savings. If your home is destroyed and you self-insure, you will likely want to have enough money to pay for the rebuilding costs of your house as well as to replace any of your belongings that were damaged.

Self-insurance may also be an option for renters. Rather than buying renters insurance, you may choose to self-insure. Instead of paying a monthly, quarterly or annual premium, renters who self-insure instead earmark a certain amount of savings to pay for damages. When the unexpected happens, these renters can tap into those savings to replace their belongings instead of filing a traditional insurance claim. Some landlords require their tenants to have renters insurance, though, so this may not be an option for you.

Additionally, your home and personal property are not the only things covered by a traditional insurance policy. If you self-insure, you should also take into consideration the costs associated with causing damage to someone’s belongings or someone getting hurt on your property. These costs could include medical bills, legal fees and the repair or replacement cost of damaged items. A homeowners or renters insurance policy covers these situations with personal liability coverage, but if you self-insure, the burden of these costs would fall to you.

Insurance for disasters like floods and earthquakes

Homeowners insurance typically excludes damage caused by earthquakes and floods. Rather than adding an endorsement or buying a separate policy to protect your home against these disasters, you may choose to self-insure.

You will likely want to carefully evaluate your home’s risk for these disasters. If your home is in a low-risk flood zone or is substantially elevated, for example, flooding may not be a major concern. But if your home is located on a flood plain, you should know that even one inch of water can cause up to $25,000 in damage to your home. If you do not readily have that amount at your disposal for repairs, you may be better served by purchasing a flood insurance policy. Additionally, if you have a mortgage on your home and are in a high-risk area for these disasters, you may be required to have traditional insurance coverage.

Life insurance

Life insurance is designed to provide your loved ones with a financial cushion should you pass away, but a traditional life insurance policy may not be the right choice for everyone. Some people choose to self-insure for their life insurance, setting aside money throughout their life that will be left to their loved ones.

There are a lot of factors to consider when it comes to your life insurance, whether you choose to self-insure or purchase a traditional policy. You may want to make sure you save up enough to cover your funeral expenses, replace your salary for your loved ones, pay off debts or leave behind a financial gift.

Health insurance

The health insurance landscape changes frequently, and many people choose to skip coverage. Some set up a self-insurance plan, while others cross their fingers and hope to stay healthy. Before you forgo buying a policy, check with your state’s requirements. Some states mandate coverage.
If you live in a state that does not require that you have a health insurance policy, you have the option to self-insure. You should research healthcare costs in your area to determine how much money to set aside. The average American spends roughly $11,000 on healthcare each year.

Advantages and disadvantages of self-insurance

Generally, a self-insurance plan is best for those with a large pool of readily available assets and minimal risk. For example, small businesses with very few employees and significant savings may choose to establish a self-insurance group for their health benefits. Or a family with a second home may choose to self-insure the second residence, knowing it could sit vacant while they save up for necessary repairs.

As with other most financial decisions, self-insuring has advantages and disadvantages.

Advantages of self-insurance

The main perks of self-insurance include:

  • No policy limits: When you self-insure, you are not subject to any limits of coverage like you could be with traditional insurance. You can choose to save as much as you want or think will be necessary to recover after a loss.
  • Flexible fund usage: By self-insuring, you get to decide how your funds are used after a loss, giving you full flexibility to recover in the way you think is best.
  • Potential for savings: Self-insurance can seem exciting because it gives you the opportunity to save money. Without an insurance premium to pay, you could put that money into savings or toward another expense.

With fewer limitations on how to recover after a loss and the opportunity to grow your savings, self-insurance may seem like an exciting opportunity. But you should consider the potential drawbacks, too.

Disadvantages of self-insurance

Self-insurance comes with some notable drawbacks, including:

  • Planning challenges: A self-insurance plan requires just that: a plan. The most successful self-insurers are those who regularly put money into a dedicated self-insurance account and resist the temptation to use those funds for anything other than covering losses that would have been paid out by an insurance policy.
  • Legal ramifications: Your state may have requirements about your car or health insurance, and your mortgage lender may require a certain level of home insurance. Before you self-insure, make sure you will still be in compliance with requirements that pertain to you.
  • Potential for large out-of-pocket expenses: While self-insurance may give you the opportunity to save by not paying insurance premiums, you should be aware that auto, home and health losses can escalate quickly, sometimes costing tens of thousands dollars or more. Without an insurance policy to help pay for these costs, you will have to pay for damages out of pocket. If you have not saved enough, you could be facing financial devastation.

Self-insurance, like many financial decisions, is multifaceted. While it may be a good decision for some, it likely does not fit with all scenarios. If you are unsure if self-insurance is right for you, talking to a financial advisor may be beneficial.

Frequently asked questions

Why might someone consider self-insuring?

Some people consider self-insuring as a way to avoid paying insurance premiums. Generally, though, self-insurance is best for people with a significant amount of assets at their disposal. If you are considering self-insurance because your budget is already tight, there are often other ways to save money. For example, you could get quotes from multiple insurers and switch companies if you find a policy that costs less.

Is self-insurance an option for all policy types?

Not necessarily. Almost all states require that drivers buy at least minimum levels of auto liability insurance, for example. Before deciding to self-insure, you may want to confirm that doing so would still meet any requirements that are placed on you, such as requirements imposed by your state or mortgage lender.

How much does self-insurance cost?

The amount you will need to set aside when you self-insure will depend on your specific situation. If you are self-insuring your home, for example, you will likely need quite a bit more money saved than if you are self-insuring your vehicle, since homes generally cost more than cars. Talking to a financial advisor could help you determine how much you should save if you decide to self-insure.

Written by
Kacie Goff
Personal Finance Contributor
Kacie Goff is a personal finance and insurance writer with over seven years of experience covering personal and commercial coverage options. She writes for Bankrate, The Simple Dollar, NextAdvisor, Varo Money, Coverage, Best Credit Cards and more. She's covered a broad range of policy types — including less-talked-about coverages like wrap insurance and E&O — and she specializes in auto, homeowners and life insurance.
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