In today’s world, increasing financial resilience is challenging yet when done correctly, self -insuring can provide significant cost savings, flexibility and control.
Insurance is better mainly for losses that we cannot afford and as a result some policies, or coverage options may not be great financial investments.
Self-insuring can be done in the form of higher deductibles, co-insurance, lower limits, or not purchasing an insurance policy all together.
People self-insure risks every day – cell phones, travel, going online, skiing, etc. Sometimes the “pros” make self-insurance seem scary or out of reach for average consumers (often in an effort to sell them something), that’s not the case. It just comes down to understanding the risk/reward of a particular risk.
Self insurance requires a rainy day fund, which means putting aside money should an event occur, By saving money on insurance premiums, you can invest that money and benefit from the compound interest of your savings.
Self insurance requires financial discipline and a holistic approach. Increased awareness to risk must also be considered.
Here is a general rule of thumb: Insurance is usually built for losses that we cannot afford or it will be too expensive for us to cover. When we can afford the loss, insurance may not have the best return on the investment and as a result, it might financially not always make sense.
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. However, you will need to be financially disciplined and to not actually invest the additional savings rather than spending it. Also, the investments should not be made into highly illiquid opportunities, so that in the event of loss, funds can easily be made available.
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.
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.
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 and the cost of affording them might outweigh the cost of purchasing insurance.
The second option is to tweak your insurance policy to optimize for protection and price. You can do this by choosing:
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.
Let’s start with how the economics for insurance work. Putting aside the investment, for most common insurance products, there are 4 key metrics: Gross Written Premiums (GWP), Loss Ratio, Expense Ratio, Underwriting Profit.
These metrics are important because it’s how an insurance company prices a premium based on an individual’s risk profile.
For example, what is the statistical likelihood of a 35 year old, male, in the zipcode of 94085, and no driving accident to have a claim of $50,000?. If the odds of that is a 1% chance to happen this year, then the expected loss for that profile is $500.
Using that number, insurance companies add their overhead expense ratio and charge you a premium. For our example, if the company has an expense ratio of 35%, your premium would be something around 135% of $500, or basically $675. Basically, the $500 is the money they expect to pay to people like you on average, and the $175 is their profit.
So why all this technical jargon? Because this is the key to why self-insurance can be great for all risks that you can afford.
Let’s walk through an example: Let’s say you have $30,000 in your rainy day fund, and you have a $5000 car. Imagine you are trying to decide to purchase comprehensive insurance for your car or just collision damage. If the expected loss for someone like you suffering from a total loss ($5000) is $300 a year, the insurance company with a 35% expense ratio will probably charge you around $405. That $105 is exactly the amount of money that you are expected to save that year by not spending money on insurance on average. Money can then be saved, compound interest would be significant and assets grown.
Example: How self-insurance can lower the cost of insurance
Most insurance companies who offer auto or home insurance, have to file their rates and their pricing with each state in the United States. The idea is to make the process of how pricing works transparent. These are called rate filings. Higher deductibles are more cost-efficient and actually coincide much better with self-insurance.
Here we have looked at a few major US carriers in 2020.
Please note on average the collision and comprehensive coverage are 30-40% of the total policy cost.
Example: Long Term Disability Insurance
Looking at options for a 35 year old male, we compared quotes for an elimination (waiting) period of 60 days versus 365 days. On average, the higher elimination period is 40% cheaper than the lowest option. Though, to typically cover the elimination period you can purchase a Short Term Disability insurance which usually costs as much as the Long Term Disability Insurance, Meaning it can double the premium costs and in many cases it is not the best return on the investment.
Example: Health Insurance
Looking at quotes from Blue Shield of California for a PPO plan, we compared a high deductible Bronze (Co-insurance of on average 40%) plan, with a Gold (average 20% Co-insurance), with a Platinum (average 10% Co-insurance). The respective plans cost $1659, $2600, $3400 a month. Meaning that the Platinum plan costs twice as much as the high deductible plan.
For a single 35 year old male, the Platinum plan costs a little over $1000, whereas the High Deductible plan costs around $500.
Self-insurance will work better in some situations than others, while in some cases, it won’t work at all.
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 saved away for covering unexpected expenses, which we usually call an emergency fund.
Finally, the decision should always be based on an individual’s risk profile, objectives, and personal financial situation. 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.
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.
Insurance is essential, yet the premiums add up quickly and it takes knowledge and analysis to truly lower the costs. Learn more.