Definition
Self-insurance is a risk management technique in which a company or individual sets aside a pool of money to be used to remedy an unexpected loss instead of purchasing an insurance policy from an insurance provider. This financial strategy involves creating a reserve fund used to pay claims as they arise.
Self-insurance is often employed to protect against high-frequency, low-severity losses, which can be predictable and manageable by the entity taking on the risk. This strategy can provide cost savings and flexibility but requires diligent management of the reserved funds.
Examples
- Corporation Health Programs: Large corporations may opt to self-insure their health insurance programs, setting aside funds to pay for employee health claims.
- Public Entities: Municipal governments might self-insure for workers’ compensation claims, maintaining a fund dedicated to such liabilities.
- Property Management: Real estate firms might self-insure for minor property damages and maintenance, using a dedicated account to cover these predictable costs.
Frequently Asked Questions
Q1: What are the benefits of self-insurance?
- A1: The benefits include potential cost savings, increased control over claims processing, and the ability to tailor a program specifically to the insured entity’s needs.
Q2: Are there any risks associated with self-insurance?
- A2: Yes, the main risks include misestimating the required reserve funds, potential for large losses exceeding the reserved amount, and the need for proper management and oversight.
Q3: How does a company determine the funds needed for self-insurance?
- A3: Companies generally use actuarial analysis to predict the frequency and severity of potential losses, then set aside sufficient funds to cover those predicted losses.
Q4: Can individuals self-insure?
- A4: Yes, individuals can self-insure for predictable expenses such as dental care, vision care, or setting aside funds to cover high deductibles in traditional insurance.
Q5: Does self-insurance require regulatory compliance?
- A5: This depends on the jurisdiction. In some cases, self-insurance requires approval from regulatory bodies and must meet specific financial solvency standards.
Related Terms
- Risk Management: The process of identifying, assessing, and controlling threats to an organization’s capital and earnings.
- Reserve Fund: Money set aside to cover future liabilities or losses.
- Actuarial Analysis: The statistical method used to evaluate financial risks in the sectors of insurance and finance.
- Deductible: The amount paid out of pocket by the policyholder before an insurance provider will pay any expenses.
- Workers’ Compensation: A form of insurance providing wage replacement and medical benefits to employees injured in the course of employment.
Online References
Suggested Books for Further Studies
- “Risk Management and Insurance” by Scott E. Harrington & Gregory R. Niehaus - Extensive study on the principles of risk management and insurance.
- “Fundamentals of Risk and Insurance” by Emmett J. Vaughan and Therese M. Vaughan - Comprehensive insights into the fundamental aspects of risk and insurance.
- “Principles of Risk Management and Insurance” by George E. Rejda - Detailed examination of risk management and insurance principles.
Fundamentals of Self-Insurance: Insurance Basics Quiz
### What is self-insurance primarily used to protect against?
- [x] High-frequency, low-severity losses
- [ ] Low-frequency, high-severity losses
- [ ] All types of losses
- [ ] Specifically medical-related losses
> **Explanation:** Self-insurance is often employed to protect against high-frequency, low-severity losses, which are more predictable and manageable.
### Which of the following is a key benefit of self-insurance?
- [x] Cost savings
- [ ] Guaranteed coverage for all types of losses
- [ ] No need for fund management
- [ ] Less regulatory compliance
> **Explanation:** One of the primary benefits of self-insurance is the potential for cost savings by eliminating the need for third-party insurance premiums.
### What is essential for a successful self-insurance program?
- [ ] Random deposit amounts
- [ ] High reliance on external borrowing
- [x] Proper management and oversight of reserve funds
- [ ] No predictive analysis
> **Explanation:** Successful self-insurance requires diligent management and oversight of the reserved funds to ensure they are adequate to cover potential claims.
### Which entity can typically self-insure for workers' compensation?
- [ ] Small businesses with fewer than 10 employees
- [ ] Only individual policyholders
- [x] Municipal governments
- [ ] All non-profits
> **Explanation:** Large organizations, including municipal governments, often self-insure for workers' compensation claims due to their ability to predict and manage such liabilities.
### How can companies determine the amount needed in reserve for self-insurance?
- [ ] Random selection
- [ ] Using a standard industry percentage
- [x] Actuarial analysis
- [ ] Approved by employees
> **Explanation:** Companies typically use actuarial analysis to predict the frequency and severity of potential losses to set aside sufficient funds.
### Who might NOT benefit from self-insurance?
- [x] Small businesses with unpredictable cash flows
- [ ] Corporations with large reserves
- [ ] Public entities
- [ ] Real estate management companies
> **Explanation:** Small businesses with unpredictable cash flows might struggle with self-insurance due to the potential for significant financial strain.
### Which of the following is a drawback of self-insurance?
- [x] Misestimating reserved funds
- [ ] Immediate loss coverage
- [ ] High external control
- [ ] Lower deductibles
> **Explanation:** One of the main drawbacks of self-insurance is the risk of misestimating the required reserve funds, potentially leading to underfunding.
### Is regulatory approval always required for self-insurance?
- [ ] Yes, globally
- [ ] No, self-insurance is unregulated
- [x] It depends on the jurisdiction
- [ ] Only for health insurance
> **Explanation:** Whether self-insurance requires regulatory approval depends on jurisdiction and the type of self-insurance being considered.
### What is one characteristic NOT typically found in self-insurance?
- [ ] Tailored program for specific needs
- [ ] Increased control over claims
- [x] Absolute external risk transfer
- [ ] Potential cost-saving
> **Explanation:** Self-insurance generally does not involve absolute external risk transfer, as the entity retains the risk and manages claims themselves.
### For self-insurance, what type of losses can't usually be covered effectively?
- [ ] High-frequency, low-severity losses
- [x] Low-frequency, high-severity losses
- [ ] Minor incidental expenses
- [ ] Predictable maintenance costs
> **Explanation:** Self-insurance is typically not effective for low-frequency, high-severity losses, as such unexpected and costly events could overwhelm the reserved funds.
Thank you for exploring the complex world of self-insurance with us. Continue to expand your knowledge and protect your assets wisely!
