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Advantages & Disadvantages of Self-Insurance

Self-insurance is a risk management strategy where an organization allocates funds to cover losses from certain risks, instead of purchasing insurance from a traditional insurance carrier.

Self-insurance allows organizations to have more control over coverage, tailor policies to meet their specific needs, and potentially save money on premiums.

However, self-insurance also has some disadvantages, including financial risk, administrative burden, and the need to allocate capital to cover potential losses. As a result, organizations considering self-insurance must carefully evaluate potential risks and benefits before deciding whether it is the right choice for them.

If you’re thinking about becoming self-insured, you’ll need to weigh the pros and cons of taking this type of approach. We’ve outlined the advantages and disadvantages in further detail below.

Advantages of Self-Insurance

There are many advantages that come with self-insurance, which explains why this alternate strategy has become so popular.

Cost savings

One of the key advantages of self-insurance is the cost savings it can provide. By setting aside funds to cover potential losses, organizations can significantly reduce their insurance costs.

With self-insurance, there are no premiums, commissions, or fees commonly associated with the commercial insurance market. This can result in significant savings over time.

Tailored coverage options

Another advantage of self-insurance is the flexibility it can provide. With self-insurance, organizations can tailor their insurance coverage to meet their specific needs. This allows for more control over the claims process and coverage features.

This flexibility can be particularly beneficial for organizations with unique risk profiles or specific insurance needs that are not addressed by traditional insurance providers.

By creating a customized self-insurance plan, organizations can ensure that they are protected in the areas where they need it most, and specific to their needs.

Increased cash flow

Self-insurance can also provide cash flow advantages. With traditional insurance policies, premiums must be paid to the insurer on a regular basis, regardless of if a claim is made.

In contrast, a self-insured entity will set aside funds to cover potential losses as needed. Funds are only used when necessary, potentially providing improved cash flow for an organization.

Also, by setting aside funds for potential losses, organizations can earn interest on those funds, further improving cash flow.

Control over claims process

Additionally, self-insurance allows for more control over the claims process, which can lead to faster and more efficient resolutions, along with reduced costs.

With traditional insurance, the claims process is managed entirely by a third party. There is reduced transparency as to who is controlling the process, what might cause delays, and the outcome can be less predictable.

By bringing that entire process in-house, you will have complete visibility (and control) of the internal claims process, and will be able to address any problems or identify the source of delays quickly.

Disadvantages of Self-Insurance

Despite the benefits listed above, there are a number of potential downsides to self-insurance that you should be aware of.

Financial risk

One of the main (and most obvious) disadvantages of self-insurance is the financial risk it entails. When an organization self-insures, they are taking on the financial risk of potential loss themselves, which can be significant in the event of a catastrophic event or large claim.

Large claims can be financially devastating if the funds set aside for self-insurance are insufficient. An entity that is self-insuring has no risk diversification to stabilize losses in a given year and are much more exposed to volatility. Self-insured entities, need to manage the risk they are taking on carefully. Because of the potential financial burden, self-insurance may not be feasible for smaller organizations as they likely won’t have financial resources to set aside funds for potential losses. According to a study by the U.S National Association of Insurance Commissioners, 60% of businesses that self-insure report claims of less than $10,000, while only 6% report claims of over $100,000.

Administrative burden

The administrative burden of self-insurance can be significant, requiring expertise in managing the retained risk, including policy wording expertise, risk management, claims handling, and financial management.

Small organizations may not have the resources to handle these responsibilities effectively, making self-insurance less feasible for them, and they may need to consider alternative insurance options to manage risk effectively.

Ultimately, the financial risk and administrative burden associated with self-insurance must be carefully considered before deciding if it is the right choice.

Unpredictability of losses

Another disadvantage of self-insurance is the risk of unforeseen losses. Organizations who self-insure are responsible for covering the full cost of any retained losses, which can be difficult to predict or plan for.

As noted by the U.S. Government Accountability Office:

“Self-insurance is subject to the risk that losses will be greater than expected or that unexpected events will occur.”

In addition, a study by the Society of Actuaries found that self-insured organizations experienced higher-than-expected claims costs in 35% of cases. This highlights the unpredictability of losses and the potential financial risks associated with self-insurance.

Consequently, organizations considering self-insurance must carefully evaluate the potential risks and ensure they have sufficient resources to cover any unforeseen losses that may occur.

Considering self-insurance for your business?

Self-insurance can provide cost savings, flexibility, control, and improved cash flow. However, it also carries financial risk, administrative burden, resource challenges, and the possibility of unforeseen (or catastrophic) losses.

Before considering whether self-insurance is right for you, it is important to evaluate the potential advantages and disadvantages and determine if it is a feasible option for your organization.

It is best to consult with a qualified insurance professional to determine the best approach for your specific circumstances.

Here at Axxima, our insurance experts can help your organization assess the benefits of self-insurance and develop a tailored solution to make sure you’re covered for the risks your business is likely to face.

Get in touch with our team today to discuss your options.