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Is Self-insurance an Effective Risk Management Strategy for Your Business?

Risk management is an essential cornerstone of any organization and insurance is a critical component of this.

Traditional insurance is the steadfast risk transfer strategy to protect against unforeseen events that could disrupt operations, or erode a company’s financial position. Insurance offers a reassuring safety net by allowing businesses to shift the financial burden of unexpected adverse events to a trusted insurer through the payment of regular premiums.

However, as businesses continually evolve, so do their strategies for risk management. One such concept that has garnered significant attention is self-insurance. This approach involves an organization setting aside funds to directly cover potential losses, forsaking the traditional route of paying premiums to external insurance providers.

Below, we’ll explain how self-insurance can be an effective risk strategy for businesses, including some examples.

Insurance as a business risk strategy

The fundamental premise of insurance rests upon the principle of risk transfer.

With traditional insurance, businesses pay regular premiums to insurers to transfer the financial liability of certain unanticipated events to specialized risk bearers. These events  can include risks such as accidents, property damage, natural disasters, product liability or cyber breaches. Terms of reimbursement are addressed in insurance policies and by entering into these contracts, companies secure themselves against diverse and sometimes catastrophic uncertainties.

What is self-insurance?

Self-insurance is a risk management strategy in which an organization sets aside their own funds to cover potential losses instead of relying on traditional insurance policies provided by insurers. Self-insurance can be as modest as assuming a higher deductible or retention on a particular type of insurance, or as complex as assuming all losses for a particular risk typically assumed by a traditional commercial insurance carrier.

Rather than paying regular premiums to an insurance company, self-insured entities directly assume some or all of the financial responsibility for certain risks. This approach involves building up a financial reserve, often referred to as a “self-insurance fund,” to cover costs associated with unexpected events.

Is self-insurance an effective risk strategy?

Self-insurance can be a highly effective risk strategy for companies with substantial financial reserves and robust risk assessment and management systems in place. However, it may not be suitable for smaller enterprises with limited financial resources, as they could face significant financial hardship in the event of a catastrophic loss.

Benefits of self-insurance as a risk strategy

Self-insurance offers a range of advantages, contributing to its growing popularity as an alternative risk management strategy to traditional insurance.

Cost efficiency

One of the primary benefits of self-insurance lies in its potential for cost savings. By earmarking funds to cover potential losses, organizations can significantly reduce their insurance-related expenses.

Unlike traditional insurance, self-insurance eliminates the need for premiums, commissions, or fees commonly associated with commercial insurance. Over time, these cost reductions can translate into substantial savings, freeing up financial resources for other operational needs.

Some companies may also be motivated towards self-insurance if they feel that that have a risk profile that is better than their peer group, as insurance premiums charged by an insurer will usually be influenced by losses experience generally with the class of risk.

Customized coverage

Another advantage of self-insurance is the ability to tailor coverage to specific requirements. Organizations can customize their insurance plans to align precisely with their unique needs.

This adaptability enables greater control over the claims process and the selection of coverage features. It is particularly advantageous for organizations with distinct risk profiles or specialized insurance needs that may not be adequately addressed by the conventional insurance market.

Enhanced cash flow

Self-insurance can also boost an organization’s cash flow. Unlike traditional insurance policies that require regular premium payments, self-insured entities set aside funds to cover losses as they occur.

This pay-as-you-go approach conserves financial resources, potentially leading to improved cash flow and investment returns.

Control over claims process

Self-insurance empowers organizations with greater control over the claims process, resulting in faster and more efficient claim resolutions, as well as reduced costs.

Unlike traditional insurance  where third parties oversee the claims process, self-insured entities bring the process in-house, ensuring complete visibility and control. This shift enables organizations to promptly address any issues, identify the sources of delays, and enhance predictability throughout the claims process.

The result is a more streamlined and cost-effective approach to handling claims.

Considerations when becoming self-insured

Notwithstanding the above, the effectiveness of self-insurance as a business risk management strategy depends on various factors, including the financial strength of the business, the nature of its operations and the regulatory environment.

We’ll outline these considerations in more detail below.

Financial capacity

Self-insurance demands a robust financial backbone to absorb the costs associated with unexpected events. This entails setting up a dedicated self-insurance fund which can require a substantial initial capital injection and ongoing funding. This fund serves as a financial safety net, covering losses when they occur.

For example, large corporations who have financial prowess may decide to self-insure certain aspects of their business. They allocate a portion of their extensive financial resources to handle potential claims.

This financial commitment allows them to manage risks directly, but it also means they must maintain substantial reserves to ensure they can meet their financial obligations when claims arise.

Your risks

Conducting a thorough risk assessment is a fundamental step in the self-insurance process. This involves identifying and evaluating the specific risks your organization faces. Each type of risk is analyzed to determine the likelihood of occurrence and its potential financial impact. By quantifying these risks, organizations can make informed decisions about self-insurance.

For example, in the manufacturing sector, self-insurance may be a viable option if the company determines that it can cover potential product liability claims through its self-insurance fund, taking into account the expected frequency and severity of such claims.

To use another example, a trucking company may opt for self-insurance in the context of motor vehicle accidents. They may be able to analyze accident data, assess driver safety programs, and determine the potential costs of accident-related claims.

Regulatory environment

Another important consideration with self-insurance is that it must be practiced in accordance with the law. Depending on the size and structure of a self-insurance entity, it may be governed by applicable provincial insurance acts, and federal law. In addition, some industries and types of insurance have specific restrictions  on what is possible to self-insure.

Risk management expertise

Effective risk management is a linchpin in the success of self-insurance. It’s not just about having the financial capacity. It’s also about managing risks and claims efficiently. This requires specialized expertise in risk assessment, claims handling, and loss prevention.

Many self-insured organizations either have in-house risk management departments and/or partner with third-party administrators with expertise in self-insurance programs as self-insured organizations must invest in the necessary expertise and resources to manage risks effectively and ensure the success of their initiatives.

Considering self-insurance for your business?

While self-insurance offers numerous benefits, it’s essential to acknowledge that setting up a program can be complex and heavily regulated.

The regulatory landscape, risk assessment, and financial aspects involved in self-insurance risk strategies require careful consideration. Navigating this terrain can be challenging, especially for organizations new to the concept.

At Axxima, we’re insurance consultants that specialize in self-insurance and who can provide valuable insights, expertise, and support throughout the self-insurance journey from the initial feasibility assessment phase through all the way to program management.

With our in-depth knowledge of self-insurance practices, we can help you navigate the regulatory requirements, optimize your risk management strategy, and tailor a self-insurance plan that aligns with your specific business needs.