How to Self-Insure and Why Smart People Do It?

Self-insuring means saving enough money as a rainy day fund and optimizing your financial and general well-being. 

Share on facebook
Share on twitter
Share on linkedin

What it means to self-insure

Insurance premiums can quickly add up: healthcare, car, house, disability and life, just to name a few. And if you never claim, it can easily feel like you are pouring money down the drain. There is another option – self-insuring. But you want to be careful.

When you self-insure, you set aside extra money to pay out of your pocket for any losses or damages, if and when they occur instead of paying a premium to an insurance company to cover your losses when they occur.

The basic idea behind this is that you will save money by avoiding making regular premium payments so that you have money to pay for damages if a loss occurs — which may or may not ever happen.

Self-insurance and risk management

Risk is a fact of life. We can make active decisions on how we want to handle risk, and in doing so, we have several options at our disposal. 

The first option is avoidance; this is when you eliminate the source of the risk. For example, if you don’t own a car, you cannot have your car stolen. The second option is loss control, where the point is not to eliminate the risk, but to reduce/control it by, for example, wearing a seatbelt while driving.  The third option is the contractual risk transfer to others. For example, when you rent a car, the company transfers the risk of car damage to you. The fourth option is insurance, where you transfer the costs of losses to an insurance company.

And the final option is risk retention, where you keep the risk and pay part or all of the losses when they occur. This is self-insurance. Self-insurance is the process of establishing a fund that you will use to cover the costs of a loss. It does not eliminate or control risks; it provides a means of covering losses that you will have only if the damaging event occurs.

Things to consider when you self-insure

Self-insurance will work better in some situations than others, while in some cases, it won’t work at all.

  • First, keep in mind that some insurance coverages are legally required, such as auto insurance required by state regulations (though liability loss limits will vary between states) and health insurance. Homeowners insurance will be required for those who bought their homes through a mortgage.
  • Second, self-insurance will depend on the financial buffer that you have, or excess money stashed away to cover a loss.
  • Third, a key factor when considering self-insurance is the potential size of a loss assessed against your own financial resources.

Self-insurance is a useful approach in the case of smaller and predictable losses. In other words, the lower the potential loss or, the more predictable it is, the more it makes sense to self-insure. For example, you might choose to self-insure against a car accident with a $500 deductible on auto insurance collision coverage, but carry $100,000 of liability coverage to protect you in case of a lawsuit resulting from a bigger accident.

However, it is important to keep in mind that you can’t look at the potential loss in isolation – you need to look at it from your own financial perspective. This is why you need to assess the size of potential loss against the money you have stashed away for covering unexpected expenses, which we usually call an emergency fund.

The standard advice is to keep an emergency fund equal to at least three months’ worth of your expenses. But the reality is that many people live paycheck to paycheck, which means they don’t have that money available. If you don’t have funds to cover unexpected losses out of your own pocket, it doesn’t make sense to self-insure.

How to self-insure

You can self-insure by dropping certain insurance altogether or by being very intentional when choosing an insurance policy.

In the first case, you are left without any coverage for a particular risk, which means that you will be responsible for the full amount of losses. This approach may not work well with certain policies. For example, some policies may be required by the law. Also, self-insuring for events that may result in extremely high expenses, such as critical illness (heart attack, stroke, organ transplants, etc) may not really make financial sense.

The second option is to tweak your insurance policy to optimize for protection and price. You can do this by choosing:

  • Insurance policies with higher deductibles as they have lower premiums, so cost less. This means that up to an amount equal to the value of the deductible, you will be responsible for covering your losses. When your losses exceed the value of the deductible, the insurance company steps in and covers your losses. Additionally, it means that you choose to self-protect up to the value of the deductible and save your insurance for higher-cost events, which would be much harder to cover out your own pocket. Limit the coverage and choose more restrictive options. Be intentional about the protection that you need and pinch out any excess coverage that may look good on paper, but you don’t really need. For example, if you have an old car, dropping your collision coverage does make financial sense.

     

  • Choose policies with a long elimination period. The elimination period, often found in long-term care and disability insurance policies, is the time you need to wait before your benefits kick in. Longer elimination period policies have lower premiums. Short-term disability insurance will have a shorter elimination period, usually up to 14 days. Long-term disability insurance policies typically have an elimination period ranging from 30 to 365 days, but some insurers offer even 720 days elimination period – so there are plenty of options to choose from.

Keep in mind that self-insuring doesn’t mean that you go uninsured. Instead, it means that you assume responsibility for financial losses that you may incur, rather than shifting these risks to an insurance company.

It also doesn’t mean that you just randomly drop whatever insurance policy, rather that you are being very intentional about selecting a coverage you really need.

Why smart people choose to self-insure

Self insurance offers numerous benefits, when done correctly. One obvious benefit is reduced costs by avoiding higher premiums. Money saved can then be invested allowing increased savings.

Self-insurance also promotes good habits. People tend to make better choices when they know they will bear consequences of the decisions they made. Self insurance also gives you a sense of control over finances due to the active steps taken to optimize your financial and general well-being. 

Life is full of risks. To your family. Your assets. Your future. The problem is traditional solutions propose traditional answers. Let’s make sure you’re protected.

Do you have the protection you need?

Life is full of risks. To your family. Your assets. Your future. The problem is traditional solutions that propose traditional answers, one policy at a time.

Vero’s fast and free Protection Plan is an unbiased analysis of all your risks. We’ll recommend what insurance to buy — and which policies you can safely cancel to save money.

Continue reading

©2020 Vero Intelligence, Inc.
370 Convention Way
Redwood City, CA 94063

Follow us