Self-insurance

What is self-insurance?

Self-insurance is the process of insuring oneself instead of buying insurance from an insurance company. A person or organization practicing self-insurance sets aside money to cover the losses that insurance would normally cover.

When a person has insurance, they can turn to their insurance provider to pay for losses covered by the policy. For example, home insurance pays to repair a house after a fire, and car insurance pays for repairs after an accident. A self-insuring person would need to pay these costs out of their own pocket.

Self-insurance isn’t an all-or-nothing situation; most people self-insure some things even if they aren’t aware of it. For example, if you buy a car insurance policy and decline collision coverage, you’re self-insuring damage to your vehicle from at-fault collisions. Renters that don’t buy tenant insurance are self-insuring their belongings, personal liability, and everything else that tenant insurance covers.

Did you know that insurance deductibles are a form of self-insurance as well?

The deductible is the portion of a claim settlement that the policyholder pays before their insurance covers the rest. That’s why raising your deductible lowers the price of your policy—you’re taking on more of the insuring responsibility yourself.

When does it make sense to self-insure?

Total self-insurance—carrying no insurance whatsoever—isn’t generally wise for individuals. Some large businesses practice self-insurance because they have enough cash available to cover expected losses. To completely self-insure, you would need to have the resources to cover the worst loss you could theoretically face.

For example, for a homeowner to properly insure themself, they would need to have access to enough money to rebuild their house if it were destroyed. Renters might have an easier time self-insuring their home, but they’d still need to cover the cost of replacing their possessions or paying any legal damages for which they’re liable.

It may seem like the odds of suffering a massive loss—like the house burning down—are small enough that the risk is worthwhile. But, it turns out that humans are terrible at calculating risk. Insurance companies, meanwhile, are an entire industry based on risk calculation; it’s usually best to pay a fixed premium and leave the actuarial science to them.

There’s also the fact that sometimes you can’t self-insure. For example, third-party liability coverage is mandatory for all drivers in Canada. Anyone with a mortgage on their home must have an active home insurance policy. Many professionals need to have commercial liability or errors + omissions insurance, too.

So, when does it make sense to self-insure?

Perhaps if you’re extremely wealthy—like, nine or ten figures wealthy. Those sorts of people have the resources to opt out of insurance if they want. Of course, many still have insurance; life insurance makes sense for a wealthy individual, and car insurance is mandatory regardless of one’s net worth.

For the regular folk, total self-insurance doesn’t make financial sense. But there are specific scenarios where self-insurance is valid.

For example, let’s say you’ve suffered an insurable loss that’s relatively small—like having your $500 cell phone stolen. While your home insurance could cover this loss, it might make more sense to self-insure and just buy a new phone. If you made a claim, you’d still have to pay your deductible, which could be the whole $500 anyway. Plus, your premiums might increase after the claim, eating into whatever you saved by making it.

Insurance is meant to cover large losses that people can’t deal with on their own. So, it does make sense for someone to self-insure small losses if they can afford it.

Another example:

If your home is located on a floodplain, you may have trouble finding home insurance. But, you could self-insure against flood damage either by agreeing to a policy without flood coverage or one with a high flood deductible. If you did, you might find a provider willing to insure the rest. Same thing for homes in earthquake-prone regions: by self-insuring losses from high-risk perils, a homeowner might secure affordable home insurance that would otherwise be too pricey (or unavailable).

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