Pros and cons of self-insurance.
Self-insurance is an insurance strategy for mitigating future losses by setting aside a portion of your own money. This is contrary to buying an insurance policy from a traditional insurance company. Coming up with the appropriate contribution level to this self-insurance fund may be a complex exercise requiring consulting experts and should be executed within the confines of the budget.
An example of self-insurance is as follows:
Healthcare: Some individuals or companies may self-insure their health benefits. This means that they are responsible for paying for all healthcare costs, rather than purchasing and insurance policy.
Though self-insurance may seem to be a noble idea, it has its advantages and disadvantages.
Pros.
- Cost savings: Insurance is a cost and the use of self-insurance can save money on premiums. Self-Insurance is best for individuals or companies that are likely to experience infrequent or minor losses.
- Flexibility: With self-insured you can tailor it to your specific needs. You also define the contribution levels and how the funds will be invested.
- Control: Self-insured entities are not bound by the terms and conditions of an insurance policy. This gives them more control over how claims are handled.
- Cash flow: Self-insured individuals or companies can earn interest on the funds they set aside. The invested funds will be beneficial to the individuals or entities.
- Better risk management: Self-insurance encourages you to focus more on risk management. This is because you will be responsible for paying for any losses that occur.
- Data Management: Self-insured individuals and businesses have access to more detailed data about their losses. This can help them to better manage their risks.
- Coverage: Self-insured individuals and businesses have the ability to alter coverage to meet their specific needs, which can be beneficial for businesses with unique risks.
Cons.
- Financial risk: The financial risk is huge as self-insured entities are responsible for paying for all losses, even those that are catastrophic.
- High administration costs: Tracking and managing claims is a complex process and individuals may be incapacitated to handle such a process. For businesses it is an additional cost that may be out of their line of business.
- Huge Capital requirements: Self-insurance does not get the benefit of pooling of risks. Therefore self-insured entities must have enough money set aside to cover potential losses.
- Loss of bargaining power: Self-insured individuals and companies have less bargaining power with service providers, which can lead to higher costs in the event of a loss.
- Lack of the requisite expertise: IF you are self-insured you may not have the expertise to manage claims and risks effectively. This may manifest in under-provisioning for losses or poor investment decisions.
- Risk of insolvency: If a self-insured business experiences a large loss e.g. during a catastrophe, it could become insolvent.
Conclusion.
Self-insurance can be a good option for businesses that are willing to take on financial risk and have the resources to manage claims effectively. On the contrary, self-insurance is not advisable to individuals as most do not have the expertise to understand the risks and manage them. However, it is important to carefully weigh the advantages and disadvantages before deciding whether self-insurance is good for you. In most circumstances, it is prudent to engage experts in the insurance industry though it will come at a fee.
