Insurance, as a concept, is the process of transferring the financial risk of loss from you onto an insurance company. Insurance companies have cash reserves that are available for your use to provide financial relief in the event of a financial catastrophe. This protection comes at a price, however -- you pay a premium for the service. If you want to try to retain this risk yourself, you would self-insure. Self-insurance does have advantages, but it also has disadvantages associated with it.
Control Investment and Reserves
When you self-insure, you choose the investments you want to invest in, within reason. When a business uses self-insurance for health insurance, the investments do have to follow some guidelines, though the guidelines vary by state. The process of self-insuring means you may take additional risks in your investments that an insurance company wouldn't or couldn't take. You may end up with sufficient cash reserves at a lower effective premium cost than if you had used an insurance company to transfer the risk away from you.
Control Benefit Payments
With self-insurance, you can control when "claims" are paid. With an insurance company, there may be claim forms to fill out and you may have to have your claim approved by an adjuster. When you self-insure, you won't have any of that to worry about. You simply withdraw the funds as needed. When you withdraw the funds from your bank account, or whatever investment account you're using for your cash reserves, you may spend the money any way you wish. With an insurer, the insurance company may otherwise specify how those funds are to be used and may require proof that the funds were used a certain way.
When a business tries to self-insure, it may be subject to strict regulations. This is especially true in the case of health insurance. A corporation wishing to self-insure for medical expenses often needs to establish significant cash reserves, which may hinder the company's ability to spend money on business growth. The regulations may also specify that only part of the liability may be self-insured while the company may be required to purchase catastrophic coverage in the event the company's reserves fall below a certain threshold.
Regardless of whether you're a business or individual, you're retaining all of the investment risk yourself. This could be substantial. If you have to use your cash reserves to fund an otherwise insurable event, then you may be left with low or no cash reserves to fund future insurable events as they occur. A series of unfortunate insurable events may completely deplete your cash reserve account, causing you to incur damages that you have no way to pay for. In some instances, like self-insuring for health insurance, you may be sued by creditors or employees to provide promised benefits. You may be fined by the state, in a business context, if you're unable to provide the promised benefit payments.
- "Life Insurance"; Kenneth Black, Jr. and Harold D. Skipper, Jr.; 1994
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu and Robert A. Crane; 2007