Self-insurance
In a personal finance context, self-insurance is defined as "setting aside your own money to pay for a possible loss instead of purchasing insurance and expecting an insurance company to reimburse you."[1]
In general, it is strongly recommended to protect yourself against large, infrequent losses with third party insurance.[2] Some third party coverage is even required by law, such as minimum amounts of auto insurance. But you can choose to self-insure against small infrequent losses,[2] or perhaps even against moderate size, infrequent events, if you have the financial resources.
What risks could you self-ensure?
The following table (inspired by [2][3][4]) shows the right sorts of risks and events to consider covering with self-insurance:
| Probability | Consequences (severity of loss) |
Examples | Strategies |
|---|---|---|---|
| High | Large to catastrophic | * Very dangerous sports * Living on an active volcano |
Reduce risk if possible (insurance would be very expensive or not available) |
| High | Small to medium | * Cheap printer breaks down * Roof needs replacing * Dental exam or fillings * Pet care |
* Pay with cash flow * Save for it |
| Low to medium | Large to catastrophic | * House burns down * Die young with dependents * Medical emergency overseas * Outlive your savings * Becoming disabled for years |
* Home insurance * Life insurance * Travel health insurance * Annuities * Disability insurance |
| Low to medium | Small to medium | * Extended warranties * Deductibles on home/auto insurance * Unfinished basement is flooded * Travel cancellation on inexpensive trips |
Self-insure |
How to do it
Using self-insurance saves you from paying unneeded insurance premiums. Instead, if your financial situation is in good order, you can choose to self-insure for certain risks.
Increasing your deductibles
Selecting higher deductibles on third party insurance such as home and auto is a classic form of self-insurance. Milevsky reports that for home insurance, "the difference between covering the first $500 of damage (the standard deductible on home insurance) and the first $5,000 in damage can be up to half of the usual premium."[2]
The Small Risk Fund
To be ready to pay for small infrequent losses, you may want to accumulate money in a dedicated self-insurance account. More specifically, you would deposit the premiums you are not paying to insurance companies anymore (or the reduction in premiums you got when you increased your deductibles) in a dedicated high-interest savings account (HISA); Milevsky calls this the "Small Risk Fund".[2] Obviously, this fund would be used only to cover small infrequent losses, not to upgrade to a larger TV or to replace your roof.
When the pool of accumulated money in your Small Risk Fund gets large enough, you could stop contributing to it until a "claim" depletes it. If a medium-sized infrequent loss occurs, for which you have chosen to self-insure, and your Small Risk Fund can't entirely cover it, your emergency fund could be used as a temporary back-up.
See also
References
- ^ Investopedia, Definition of 'Self-Insurance', viewed January 20 , 2017
- ^ a b c d e Moshe Milevsky (March 30, 2010). "The lowdown on insurance salesmen and warranty peddlers". The Globe and Mail. Retrieved January 21, 2017.
- ^ The Micawber Principle, The 10 Smartest Things Ever Said About Insurance, viewed January 21, 2017
- ^ Financial Wisdom Forum topic: "Self Insurance Successful Experiences / Stories?"
Further reading
- Financial Wisdom Forum topic: "Self Insurance Successful Experiences / Stories?"
- Milevsky, Moshe A. (January 7, 2010). Your Money Milestones: A Guide to Making the 9 Most Important Financial Decisions of Your Life. FT Press. ISBN 978-0137029105.
