Published March 30, 2021 • 3 minute read
Self-insurance is one such strategy, in which the business forgoes a third-party insurance policy in favor of independently setting aside funds to cover unexpected claims that may arise down the road. This can be used against virtually any type of potential damage or loss, but is not always advisable.
The logic behind self-insurance is that providers calculate premiums based on forecasted risk. These figures are designed to profit the insurance company by bringing in more money than they are likely to pay out. Under this reasoning, a business should theoretically be able to set aside funds in case an incident occurs, thereby protecting themselves without an insurance company taking a cut.
However, businesses also must be aware of the pertinent insurance regulations in their jurisdictions. Federal law requires any business with employees to hold unemployment, workers’ compensation and disability insurance, but state guidelines may also call for additional policies. Failure to comply with these requirements can lead to costly penalties, so decision-makers should speak to qualified insurance professionals in their areas before choosing a course of action.
Potential Advantages & Disadvantages of Self-Insurance
Cost: In some cases, self-insurance may be more economical for businesses most likely to face infrequent and/or minor losses. Since monthly premiums add up and claims may increase these expenses, maintaining a fund to cover costs as they arise may be an affordable alternative. For example, a business located in an area not prone to flooding may skip flood insurance in favor of self-insurance. The facility could still flood, and the business would have to pay for the associated damage. However, the relatively low risk may make self-insurance an appealing option.
Interest: The funds you earmark for self-insurance can accumulate interest until you need them, growing substantially if you don’t have infrequent losses.
More Control: With self-insurance, you’re not bound to insurance policy fine print that contains specific exclusions and stipulations. You can spend the designated funds to cover virtually any incident, and you don’t have to worry about using an insurance company’s preferred vendor list.
Potential for Significant Loss: Some types of claims can be extraordinarily costly. Even if unlikely, a business may not be able to cover such an incident through self-insurance alone. Because of this, most companies prefer to purchase third-party insurance policies to cover infrequent, though potentially significant losses they’re unlikely to be able to pay on their own.
In-House Administration: You will need a staff member or third-party administrator to manage the fund, pay out claims, and maintain records, which can reduce the cost-effectiveness and convenience of self-insurance.
Inconsistent Expenses: Since claim amounts and frequency may vary, it can be difficult to anticipate how much you need to put into your self-insurance fund.
Government Regulations: Businesses with enough employees are required to hold certain insurance policies. Failure to do so can result in hefty fines. Self-insurance may qualify, but you’ll need to be careful to stay in compliance.
Boils Down to Risk
All forms of insurance are essentially risk transfer strategies. When you purchase an insurance policy, you are paying a third-party to shoulder some of the risk. If you self-insure, however, you are choosing to retain the risk yourself.
The ideal solution for many businesses will likely be a blend of third-party policies and self-insurance. After all, most businesses are unlikely to find policies that cover all potential exposures, and taking out specialty lines for every uncommon risk you might encounter would be cost-prohibitive.
Consulting a qualified insurance professional can help you decide whether self-insurance is a viable option in your situation.
If you work with third-party contractors or vendors, collecting and maintaining their certificates of insurances (COIs) can also help mitigate risk. BCS offers powerful COI tracking tools to make the process easy. Our self-service option provides cutting-edge software to help you maintain your documentation, and our full-service solution takes it a step further with a dedicated team of compliance analysts to review your COIs. Contact us today to discuss the best options for your business.