What Is Self-Insurance? Is It a Good Option for You?
Insurance is a necessary part of life for most people. To cover yourself and your dependents, you’ll need health and auto insurance, as well as optional life insurance. If you own a home, you’ll need homeowners insurance, but even if you rent, a renter’s insurance plan will protect your belongings.
Welcome to adulthood.
All of that insurance comes at a cost. You’ll pay monthly premiums, and if you have a claim, you’ll owe a deductible. That deductible is typically hundreds of dollars. The lower the deductible, the higher your premiums.
Some choose to self-insure, putting the money aside rather than paying premiums. But there are risks with this approach, and it’s important to be aware of them before you opt out of insurance.
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What Is Self-Insurance?
If you’re self-insured, it simply means that you maintain a lump sum in an accessible account to cover emergencies. Instead of paying premiums to an insurance carrier, you set the money aside for a rainy day. Both businesses and individuals self-insure, although often it’s reserved for those who have substantial financial assets.
“Self-insurance involves an individual or a business taking on financial risk rather than purchasing an insurance policy from an insurance company,” said Shavon Roman, personal finance expert at Heal. Plan. Invest. “It means that they retain the responsibility for paying any claims or losses.”
Self-Insured Employers
You may not realize it, but many large corporations choose to self-insure instead of paying an insurance carrier. Self-insured employers pay claims for sick and injured workers out of company revenue. Most self-insured employers like that they can skip some taxes and regulations related to going through an insurance provider.
Not all businesses benefit from being self-insured employers, though. Generally speaking, a company with a payroll of at least 1,000 can see substantial cost savings from being self-insured. Even then, employers should decide whether being a self-insured employer is risky. You may end up with multiple ill and injured workers at once, dramatically cutting into your company revenue.
Pros of Self-Insurance
Unlike some self-insured employers, you as an individual likely don’t have millions in revenue coming in each year. That means it’s important to look at the pros and cons of becoming self-insured. Here are some good reasons to consider it.
1. Increased Cash Flow
The biggest draw to dropping insurance in favor of a self-insured approach is that you aren’t putting part of your income toward premiums every month. That means hundreds of dollars stay in your bank account. But before you get too excited, keep in mind that one emergency room visit can lead to hundreds of dollars in bills.
“The benefit of improved cash flow by not paying insurance premiums is only temporary,” Roman said. “This advantage lasts only until a significant risk manifests as a financial loss.”
2. Earn Dividends on Your Money
As with a self-insured employer, keeping your money means you can put it to work for you. If you can set it aside in a low-risk, high-interest asset, you may be able to grow the funds, especially if you have years of good health ahead of you.
Before you decide to self-insure, take a look at what you can earn by putting the money into a low-risk investment vehicle like a CD or money market. When interest rates are high, that money can grow. But keep in mind that when interest rates drop, your savings won’t fare as well.
3. You’ll Avoid Rising Premiums
Insurance premiums can increase at any time. In fact, your insurance carrier likely boosts them up a little at the end of each year. The average family healthcare premium has increased 22% since 2018 and 7% in 2023. That doesn’t even include your auto, home and life insurance increases.
This is especially relevant if you run a business that employs thousands of workers. Even the smallest rise in premiums can add up over multiple plans. If you’re a self-insured employer, you avoid premium increases and deal solely with the rising cost of healthcare.
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Cons of Self-Insurance
As a self-insurer, you will face a few challenges. Here are some pitfalls of becoming self-insured.
1. You May Skip Preventive Care
Skipping an insurance carrier for healthcare comes with one particularly tricky risk. Uninsured consumers and their children are more likely to skimp on preventive care, on average, and this has a long-term cost. If you only visit your general practitioner when you’re sick, you increase your long-term risk of severe illness, disability or premature death.
For businesses that have filed a legally authorized business form as self-insurers, things get even more complicated. Self-insurers have to build in ways to ensure employees have affordable wellness care. In addition to your workers compensation obligations, private self-insurers take the expense later if you skip preventive care now. Severe illnesses will cost you more in a few years than paying for preventive care now.
2. One Emergency Could Wipe You Out
“The most significant pitfall of self-funding is not having a cap on your financial liability when you need it most,” Cody Garrett, CFP®, owner and financial planner at Measure Twice Financial, said. “With health insurance, this is called an out-of-pocket maximum.”
One surgery can land you a five-figure hospital bill. When you’re self-insured, that’s an expense you’ll have to bear yourself. It might take you years to set enough money aside to fund a more serious health emergency, and you could find yourself wiping out that savings and owing money years before you expected.
3. Managing Insurance Savings Takes Work
A self-insurer takes on the responsibility of managing all those funds. Are you prepared to put the money aside? Moving it over to a standard savings account can lead to small dividends over the years, but investing in stocks can be risky. You could shift to a low-risk investment like a CD or money market account, but you’ll need to be prepared to take action if the interest rates drop and those vehicles become less lucrative.
One way to get around the time suck of doing it yourself is to go with a third-party administrator like a trusted financial advisor. An expert can help you reduce your future liability and advise you on withdrawing or moving the funds if you need to use them.
4. Business Self-Insurers Face Accountability
Group self-insurers face their own set of challenges. Private employers need to account for the funds they set aside for insurance purposes when tax time rolls around. You may have to present independently audited financial statements on demand.
Before opting to be self-insured, look into local regulations. As a self-insurer, you could be legally required to set funds aside in escrow to cover any future claims.
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Alternatives to Self-Insuring
Whether you’re lining up insurance for yourself or your employees, being self-insured is only one option. There are ways to reduce costs while still using an insurance carrier.
High-Deductible Plans
When you choose an insurance plan, you’re asked to pick a deductible. The higher the deductible, the lower your premiums will typically be. Set a high deductible, then work toward saving the full amount of that deductible. This allows you to cap the amount you’ll have to pay if you need surgery or have a serious illness.
“Choosing a plan with a higher deductible in health insurance might result in lower premium costs while still providing a safety net for substantial losses,” Roman said.
Health Savings Accounts
One of the best alternatives to being self-insured is to sign up for a health savings account. These are typically accessed through your employer, who withholds an agreed-upon amount from your paycheck, pretax, and puts it into a separate account. If your employer doesn’t offer it, check with your bank or a private provider. You can use HSA funds on healthcare expenses until you reach the age of 65, at which point you’ll be able to use them however you want.
If you have the financial strength to move a portion of your earnings to savings, an HSA could be a great solution. In 2024, you can move up to $4,150 into an HSA, or $8,300 for family coverage. Those who are aged 55 or older can save an additional $1,000 in catch-up contributions.
Pick and Choose
Insurance doesn’t have to be an all-or-nothing proposition. You can sign up for health and auto insurance while choosing to self-fund your life insurance or car insurance. An emergency fund can provide a great cushion, but crunch the numbers and determine exactly how much risk you can handle.
“The size of your emergency fund should consider your homeowners, auto and health insurance deductibles, plus the elimination period for long-term disability insurance,” Garrett said. “Consider your unique financial risks to determine which to transfer and how large your emergency savings should be.”
Becoming a self-insurer comes with some risks. But you don’t want to pay for excess insurance either. By taking a look at deductibles and managing risk, individuals and self-insured employers can protect themselves against emergencies while also reducing monthly spending on premiums.
Stephanie Faris is a professional finance writer with more than a decade of experience. Her work has been featured on a variety of top finance sites, including Money Under 30, GoBankingRates, Retirable, Sapling and Sifter.
