What it means
Insurance works by pooling risk. Many customers pay premiums, and the insurer pays the few who suffer losses, keeping a margin for costs and profit.
When you self-insure, you act as your own insurer, accepting the risk and funding losses from your own resources. The main attraction is cost.
A business that knows its claims history well may find it pays more in premiums than it expects to lose, because premiums include the insurer's expenses and profit margin. By keeping the risk, the business keeps any savings and also benefits from better control over claims.
Pure self-insurance is rare for large risks. Most companies combine it with commercial cover, for instance by accepting a high deductible (the first slice of any loss that the policyholder pays) and buying stop-loss insurance for losses above a certain limit.
This protects against rare, severe events while still saving on routine losses. Self-insurance suits risks that are frequent, small and predictable, such as minor vehicle damage or routine medical claims.
It is a poor fit for rare disasters that could threaten the survival of the business. Some insurance is also required by law, so self-insuring is not always permitted.
A sensible plan has a funded reserve, clear rules about who handles claims and regular review of the loss history. Accountants record the expected costs as liabilities when they can be estimated.
Finance teams should compare the total cost of self-insurance, including administration, with the premium quoted by insurers. Tax and accounting treatment need care.
Money put into a reserve is not always tax deductible until a loss is paid, whereas premiums to an insurer usually are. Local rules vary, so a tax adviser should confirm the position before a self-insurance plan is launched.
In practice
Real-world examples.
Example
A hotel chain with hundreds of staff chooses to pay employee medical claims from its own funds. It buys stop-loss cover to limit any single claim above $100,000. The chain saves on insurer margins in most years, and it gains data about which hotels have the most claims so it can target safety measures.
Example
A homeowner with a large cash cushion decides not to buy extended warranties on appliances. When a $400 repair is needed, she pays it from savings. Over several years she spends less than the warranties would have cost, although she accepts that one expensive failure could cost her more in a single year.
Example
A trucking company with a large fleet accepts the first $50,000 of each accident claim itself. It keeps a dedicated reserve fund to pay these claims and buys insurance for anything above that level. The deductible lowers its premiums.
Formula
Calculation
Expected saving = insurance premium - (expected claims + administration costs + stop-loss premium)
A company with a fleet of delivery vans is quoted $60,000 a year for full insurance. If it self-insures, it expects claims of $35,000, administration costs of $5,000 and a stop-loss policy costing $8,000. Total cost is $35,000 + $5,000 + $8,000 = $48,000. The expected saving is $60,000 - $48,000 = $12,000 a year, though actual claims in a bad year could be much higher.Case study
Seen in the real world.
Greenhaven Landscaping is a fictional company with 80 vehicles and a steady record of small accidents. Its premiums had climbed to $240,000 a year, and the owner, Tomas, suspected he was paying for far more cover than he needed.
His finance team reviewed five years of claims and found they averaged $130,000 a year, with none above $40,000. This is an illustrative story, but it demonstrates the method. Tomas created a reserve fund, accepted a high deductible and bought cover for catastrophic claims, and the total annual cost fell by about a third.
In the second year, a serious accident produced a large claim. The reserve and the catastrophic cover absorbed it without hurting the company, which confirmed that keeping some insurance was wise.
Watch out
Common mistakes.
- Self-insuring without building a reserve. Promising to pay losses from future income is risky if several losses arrive together.
- Self-insuring risks that could be catastrophic. A single very large loss could threaten the survival of the business, and no reserve is likely to be large enough for every scenario.
- Ignoring legal requirements. Some types of insurance are compulsory, and self-insurance may need regulator approval.
Questions
People also ask.
What does it mean to self-insure?
It means setting aside your own funds to pay for losses rather than transferring the risk to an insurer.
When does self-insurance make sense?
It works best for frequent, small and predictable losses that the business can afford to pay itself. A long and reliable claims history makes the forecast of losses more trustworthy.
What is stop-loss insurance?
It is cover that pays when losses exceed a set limit, protecting a self-insurer from a very large claim.
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