What is self insurance and will it work?
Generally, self-insurance is the idea where we put aside some money regularly for if and when something bad happens.
For some, self-insurance is a replacement for insurance. For others, it is complementary to their existing insurance cover.
In the case of using self-insurance as a replacement for insurance, an example would be instead of paying for car insurance of say $50 a month ($600 a year), we decide to put that money aside to self insure in case we get into an accident.
At this rate, over 10 years, that $50 turns into $6000 - assuming we have not invested it or saved it in an interest generating bank account. Sounds like a fair bit of money, but is it really? Perhaps if it was a minor bump, that may be sufficient but what if it was more serious? What if your car is worth $10,000 and it was written off? What if the other car involved in the accident is a new BMW worth $100,000 and it was our fault?
The question we need to ask when thinking of self-insurance is: will the amount we have saved i.e. $6000 in this example be enough to replace or repair the car if we get into an accident? Will it be enough to cover the repair or replacement cost for the other car if it was our fault?
This scenario assumes the accident takes place once in 10 years. What if it happened tomorrow? Have we got enough money saved up to pay it off or will a loan be required?
Insurance is a nutshell is about managing our risk. Financial risk. How much risk are we willing to take and if it is worth more than the cost of insurance.
The concept and logic above can be applied to other insurance decisions such as health, income, pet, etc. But when it comes to life and house insurance, it is extreme to try and self-insure given the $50 or $100 set aside each month will not quite add up to the hundreds of thousand that lives and houses are typically covered for. For house insurance, most, if not all, banks will require insurance as long as you have a mortgage with them.
The concept of self-insurance can be applied to our existing insurance. When this happens, it does not replace but is complementary to it.
One way this happens is when we set aside some money that can be used to pay off a higher excess. Excess usually goes in the opposite direction of the cost of our insurance. The lower the excess payment, the higher the premium (i.e. cost of insurance). Therefore, if we wanted to lower the cost of our insurance, a way to do this is to increase the excess payment for if and when something bad happens. Self insuring for the excess is simpler to achieve than completely self-insuring when it comes to saving for it.
For example, most car insurers will give us the option of paying the usual $400 or $500 excess. However, this can be increased to a couple of thousand dollars. Doing so will bring the cost of insurance down, sometimes considerably.
So instead of completely doing away with insurance and self-insuring, this is a meet-in-the-middle option. Spend less on insurance by saving some money for a higher excess.
Part of the equation we talked about is risk. How much risk are we willing to take instead of paying for insurance to remove it?
The other part of the equation is to consider how disciplined we are with being able to set aside money and not spend it.
Self-insurance will not work if there is no savings.
Income and net worth could be another factor in this equation. If you are earning a huge income, you may decide that you can afford to take the risk and pay for repairs, replacements or treatments out of your own pocket. But then again, it is likely that if your income is high, the assets you are protecting are worth a lot more too.
A good first step when exploring self-insurance is to understand what insurance you currently have and how much you are spending. Try Quashed to make it simple to make sense of your current insurance situation.