When some people hear the term self-insurance, they think of millionaires with piles of cash so they don’t have to buy any insurance. In reality, you can start your own self-insurance program with only $500. Here’s how:
First, a little background on insurance with an example: If you had a car wreck that involved other people with physical injuries, it could be catastrophically expensive. Let’s say $100,000 in potential financial liability. Of this $100,000 of risk exposure, you take on the first $100 of that risk and pass the rest on to an insurance company with a policy that has a $100 deductible. The insurance company may not want all of that risk, and so they may re-insure part of the policy risk with another insurance company called a re-insurer. You are actually self-insured now – the first $100 risk is yours to fund.
But there is a financial opportunity. If you could save up $500 into a savings account dedicated to self-insurance, then you would be able to afford cheaper insurance with a higher $250 deductible. Your account will now allow you to pay for 2 potential insurance claims within a year, $250 X 2 = $500. Since your insurance premium will go down with a higher deductible at $250, you can then add that premium savings to your self-insurance account each year. As your self-insurance account grows, you can raise the deductibles on your insurance coverages (health, auto, homeowners, renters, business, disability, long-term care, etc.).
In this manner, you can lower your out-of-pocket expense for insurance and the savings is piling up in one of your savings accounts. The key concept for self-insurance is: you do not need to take on 100% of the total financial risk exposure, just a small part of the risk, the cheapest and most expensive part of the risk. As was mentioned, insurance companies only accept certain risks and pass on some of the risk to others through buying re-insurance. Start small with your self-insurance account, but keep adding your premium savings into your self-insurance account so that it will grow over time. As your self-insurance account keeps growing, you can raise your deductibles over time to save even more money. Your self-insurance account is actually working hard for you. Having this dedicated fund allows you to lower your insurance premiums, and this savings is your investment return on your account, it is providing you a decent return on your money besides earning a little interest.
Anecdotal story: last week, an old colleague told me of a neighbor whose house just burned down. It was a very old farmhouse and the family had lived in it for over 40 years. Some structural defects preventing them from getting homeowner’s insurance, so they have no funds to recover or rebuild. They also have no money to replace any of their furnishings or personal effects. Instead, if they had acted as their own self-insurer, say setting aside $1,000 per year, in a 2% savings account over the last 40 years, they’d have accumulated $61,000. When this family was turned down for homeowner’s insurance, if they had been financially literate, they would have funded their own self-insurance reserve and saved themselves.