Self-Insurance

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21 Aug, 2024

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Self-insurance, or a self-insured plan, is not traditional insurance but rather a strategy in which an individual sets aside funds to protect against future losses. The primary goal of this policy is to use personal funds to cover unexpected expenses during difficult times.

Individuals and employers use self-insurance plans to protect themselves from potential risks. This strategy can improve cost efficiency and consistency while offering companies better risk coverage and taking on a greater sense of responsibility. However, self-insurance can be challenging to manage independently.

Self-Insurance Meaning

Self-insurance, or self-funded insurance, is a risk management strategy where individuals and employers assume financial responsibility for the potential loss rather than purchasing an insurance plan.
Self-insurance characteristics include lower costs and premiums, customized insurance coverage, no policy limits, etc.
The origins of self-insurance go back to ancient times, but the modern concept can be traced back to the late 20th century when it became more popularized.
However, self-insurance involves a certain degree of risk. Individuals and employers must have the financial resources and expertise to manage their insurance program, including handling claims, managing funds, and complying with reporting requirements.

How Does Self-Insurance Work?

A self-insurance fund refers to an individual's self-protection against potential risks. Instead of relying on traditional insurance policies, a person sets aside funds to use during difficult times. This strategy is commonly used by employers and individuals, particularly as a way to secure their financial future. For instance, a family head may save money separately to protect against potential life threats or risks.

In 1972, economists Isaac Ehrlich and Gary S. Becker introduced the concepts of self-insurance and protection. However, the idea of self-protection through savings dates back centuries. During the medieval era, people saved money in pots and banks to prepare for future risks or needs. As society evolved, the need for self-protection and insurance grew. Therefore, Ehrlich and Becker's concept of a self-insurance fund gained popularity in later years.

A self-insurance plan is a pre-planned strategy where individuals set aside a certain amount as insurance without applying for traditional insurance. It is a self-made, self-protecting policy tailored to individual needs. The primary factor contributing to the plan is a risk management strategy that outlines how to mitigate potential risks. However, self-insurance is only effective when the potential future loss is predictable, and individuals or companies can estimate the potential loss amount. To be considered "self-insured," individuals must obtain a self-insurance certificate from a third-party provider.

Furthermore, businesses may opt for employer self-insurance to assess risk. In this scenario, the employer acts as the insurance provider, collecting employee premiums and providing maximum-risk coverage. Companies create a special fund to store the premium amounts until a threat arises. However, employer self-insurance may also include stop-loss insurance. Additionally, the deductible amount is the claim less the premium paid before coverage starts.

Requirements

Although the requirements for self-insurance may differ depending on the type of self-insurance and the location, some general requirements include the following:

Financial stability: To qualify for self-insurance, an individual or organization should prove that they are financially stable and capable of covering any possible losses.

Legal compliance: Individuals and businesses opting for self-insurance must follow all the relevant state and federal laws and regulations concerning insurance.

Risk assessment: An individual or business opting for self-insurance must comprehensively comprehend their possible risks and a strategy to lessen them.

Administration and management: A self-insured individual or business must possess the necessary means and knowledge to oversee their insurance program, which includes processing claims, handling finances, and adhering to reporting obligations.

Approval: In some jurisdictions, approval from regulatory agencies or insurance departments may be necessary for self-insurance.

Examples

Let us look at the examples of self-insurance to comprehend the concept better:

Example #1

Suppose Chris owns a corporate firm, "Sunson Technologies," with 40 employees. He is thinking about taking self-insurance for its staff. So, the company decides to allocate a special fund that provides risk coverage to its employees during difficult times. Thus, every employee must pay a premium to the employer, which will be further used as health insurance.

Example #2

According to the 2022 Statista survey report, the number of workers covered in self-insured has spurred to 65%, compared to 2021, which was 64%. However, during the Covid-19 crisis in 2020, it was at an all-time high of 67%. In contrast, during the late 1990s (1999), the number was 44%.

Advantages And Disadvantages

Self-insurance is a crucial element of businesses as it pumps various benefits for employers and employees. However, it also has certain cons associated with it. Let us look at them:

Advantages	Disadvantages
It can be a good source of injecting cash within the company.	Difficult to develop a self-insured plan as the initial costs involved might be complex.
There are no policy limits, as the insurance is customized per the applicant's needs.	High chances of risk because some claims might be overly costly.
A good investment option to increase savings habits among individuals.	Need for a separate team to administer the insurance premiums of the employees.
Lower cost to the business as a third-party provider is not involved.	An invite to fines and penalties if a company fails to adhere to the government rules and regulations.

Self-Insurance vs Captive Insurance

Although captive insurance is similar to self-insurance, they share huge differences. Let us look at them:

Basis	Self-Insurance	Captive Insurance
Meaning	A process in which an individual or business sets aside funds to cover potential losses instead of purchasing insurance.	A type of self-insurance where a company creates its own insurance company to cover its risks.
Purpose	To self-protect from all risks without relying on an insurance policy.	To operate a bona fide insurance company that will inject cash into the company.
Participants	Individuals and employers.	Like-minded shareholders of different companies.

Frequently Asked Questions (FAQs)

What are self-insurance reserves?

Self-insurance reserves refer to funds an organization or individual sets aside to cover potential losses in a self-insured situation. These reserves are typically used to pay for any claims or expenses related to losses not covered by insurance policies.

What is self-insurance vs. fully insured?

Self-insurance is when an organization or individual takes on the financial risk of potential losses themselves without purchasing an insurance policy. In contrast, fully insured refers to an organization or individual purchasing an insurance policy that transfers the risk of potential losses to the insurance company responsible for paying out any claims.

What is self-insured retention?

"self-insured retention" refers to the financial risk an individual or organization is prepared to bear before an insurance policy becomes active. This amount represents the money the individual or organization agrees to pay from their pocket for potential losses, such as deductibles or initial payments before the insurance company takes responsibility for additional losses.