What Is Self-Insurance?

Should you just insure yourself by saving more?

Cost of living pressures over recent years have caused many of us to question every last cent of spending. One of the areas which often comes under the microscope is insurance, after all, who wants to spend on policies year after year on coverage for events that may never happen?

A possible solution to this is self-insurance.

Self-insurance is the term used to describe when a person or company sets aside funds to meet contingency or emergency needs such as injury, loss, or any other event such as, a person’s home being knocked about by an earthquake. If such an event happens, you spend the saved sum to help sort out the situation. But if the event doesn’t occur, you get to keep the money you may have otherwise paid in insurance premiums (the ongoing cost of having an insurance policy). Self-insurance works better in some situations than others and works better for some people than others.

Before we explore self-insurance further, let’s briefly talk through how insurance works.

Self-Insurance Background: Understand How Insurance Works

At its most basic level, insurance functions by pooling money from many people who pay a little, usually each month. This money goes into a large fund managed by the insurance company. When something bad happens to someone which they are insured for — like their house burns down or they experience a health event — the insurance company uses money from the overall pool to make a payment, or payments to help the person in trouble. Not everyone will need help at the same time, and statistically not everyone will need help at all, so only those who experience a bad event receive money from the fund. This way, insurance provides support to those in tough situations while allowing everyone else to benefit from the peace of mind of being covered should something go wrong.

There are a multitude of different types of insurance policies available, and virtually any individual or business can find an insurance company willing to insure them – for a price. The most common types of personal insurance policies are for life, income protection, health, and trauma, while the most common general insurance policies are for a home and vehicle. Most people in New Zealand have at least one of these types of insurance.

What Is Self-Insurance?

There is an alternative to paying an insurance company.

It’s simply accepting the risks, and instead take appropriate steps to mitigate the risk – such as setting aside funds in the form of “self-insurance”.

Why Self-Insure?

In theory, you can self-insure against any type of loss.

However, most people choose to purchase insurance to protect against the impact of potentially large and infrequent losses.

In most cases, insurance works best when the chances of something happening are very low (such as dying at age 35, or your house burning down) though if that event were to happen the impact would be devastating. For instance, many people around age 35 have a young family and a mortgage. That means there’s children who depend on them, and a spouse who might struggle to pay a mortgage and look after children without them. So, it makes sense to protect against the unlikely chance of death during that phase of life by taking out life insurance, which can usually be purchased cheaply at such an age. Life insurance will usually be established to provide a substantial lump sum to cover all number of expenses, typically including the repayment of a mortgage and any other debts, cash to fund expenses, perhaps fund the future education needs of children, and so on. If there is a spouse and children left behind, the idea is they will be appropriately taken care of.

Insurance works because it would be very difficult to set aside enough money to do things such as:

• Repay all debt, including a mortgage, should you die earlier than expected, or
• Rebuild your home if it was destroyed. This applies to most phases of life.

Considering Self-Insurance: The Factors

When evaluating self-insurance, you are deciding between the guaranteed cost of paying insurance premiums and the risk of facing a potential loss that you would need to cover entirely on your own, without the help of an insurance policy.

For some people, providing their own insurance makes more sense than paying insurance premiums. The more predictable and smaller the loss is, the more likely it is that an individual, family, or business will choose to self-insure. The logic is that as the insurance company aims to make a profit by charging premiums in excess of expected losses, a self-insured person should be able to save money

by simply setting aside the money that would have been paid as insurance premiums.

For example, someone who is fit and healthy, doesn’t drink alcohol or smoke, has a healthy family history, and who eats a healthy diet may choose to rely on the public health system instead of purchasing health insurance. Then, instead of paying an ongoing insurance premium for health insurance, they simply set aside the same funds for the eventuality that they may need treatment they can’t get within a reasonable timeframe through the public health system. They may even take this one step further by dedicating some of these funds to preventative steps such as increased frequency of doctor and medical specialist visits, a gym membership, healthier food, and so on, all of which further reduce the chances of needing significant medical treatment.

That said, read on to learn more about why even healthy people can benefit from health insurance!

Self-Insurance: Analyse the Risks

Before self-insuring, you’ll want to have a good grasp of what risks you’re taking. You’ll need to perform plenty of research to fully understand the chances of different events taking place. This might make for grim reading, but it’s a crucial step! Here are a couple of examples:

• In New Zealand, approximately 6.5% of men and 3.5% of women are expected to die before reaching age 60.
• About one in five adults (20%) reported being hospitalised at least once before reaching 60 years of age.

Then, you’ll need to understand the impact on you, and those around you, of those risks coming to pass. This will differ for each of us.

What Are the Risks of Self-Insurance?

An insurance policy is there to protect you and your loved ones, and helps you sleep at night with added peace of mind. Insurance policies help protect people from eventualities such as the risk of going bankrupt due to illness and not being able to work for a lengthy period (keep in mind ACC will only pay out in the event of an accident, illnesses are your responsibility!), natural disaster, or the main family income earner not being able to work.

Related material:

• ‍Ways you could be wasting money on insurance
• Why you should never cancel health insurance
• Is funeral insurance worth it?
• Should you cancel your insurance policy to save?

Especially for those who have a mortgage to repay and children who depend on them to keep food on the table, it is usually necessary to have most types of personal insurance (income protection, health, and life). But as people age and usually repay the debt on their home and no longer have people so dependent on them – children eventually grow up and leave home – the need for most types of personal insurance can be reduced.

One area that might be an exception is health insurance. Even the healthiest people among us can benefit from a good health insurance policy, and benefit from continuing that policy into retirement age. That’s because health cover enables:

• Fast access to high quality healthcare, avoiding public waiting lists for surgery and specialist visits.
• Meeting the difference if ACC won't cover all or part of the treatment.
• Most policies offer access to specialist drugs which aren’t covered by the public system, especially non-Pharmac-funded cancer treatments. Pharmac is the government body which chooses which pharmaceuticals are funded, or not, in the public health system.

The most recent research by the Financial Services Council showed New Zealanders are usually good at insuring our houses and cars, though concerningly, we’re among the most underinsured people of any developed country. This study also found that most New Zealanders don’t:

• Consider the risk of losing their income due to illness or serious injury.
• Have savings or insurance in place to cover short-term loss of income, such as being off work for three months.
• Actively manage financial risk, such as significant life events which can impact daily life.

Self-Insurance Isn’t Really Insurance at All, for All the English Gurus

As some readers may have already identified, while self-insurance is a commonly used term, technically it is incorrect. This is because with “self-insurance” there’s no insurance involved at all. Instead, it just represents someone accepting a risk and (hopefully!) taking their own steps to protect against it.

The Bottom Line: Should You Self-Insure?

Self-insurance is just one way to manage the possible events that life can-and-will throw our way.

Ultimately, the risks we all face, and cost-versus-benefit decisions about insuring against some of those risks will differ for us all.

If you’d like to have a no-cost initial chat with one of our financial advisers about managing risks in your life – including by self-insurance, or by establishing insurance policies to protect against worse-case scenarios – then please let us know.