Self-insurance: What is it and should you use it?

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Written by
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Reviewed by
Farmers CSR for 4 Years
UPDATED: 2022-07-27T06:08:08.832Z
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A hand dropping a coin into a light pink piggy bank to save money for self-insurance.

One of the biggest things that people often complain about is insurance. To some, it feels like a waste to make a monthly payment for something that they may never use. If you want to reduce how much you pay in insurance premiums, it might make sense to self-insure.

Here’s what you need to know about self-insuring and whether it might make sense for you.

What is self-insurance?

When you self-insure, you’re basically making sure that you’ve saved up enough money to cover potential losses to your property or to cover the cost of lawsuits in liability cases. Rather than paying a monthly premium to another auto insurance company, with self-insurance, you amass a large war chest that you can call on when needed. Self-insurance means that you're taking the responsibility for any of the financial risks resulting from the losses. This option allows the motor vehicle owner to have all of the responsibility for protecting their car. The main reason for self-insuring is that drivers want to lower their auto insurance costs. Instead of paying monthly premiums to the insurance carrier, and the company paying for repairs, the driver chooses to cover all costs related to an accident, theft or liability. You'll want to make sure that you have enough money to cover any losses, including significant ones and that you have a self-insured auto insurance reserve and an emergency fund in place to cover the payouts.

For example, rather than getting renter’s insurance, you might build up a large enough emergency fund so that if you lost all your belongings you’d be able to replace them. The hope, of course, is that you won’t have to tap into your self-funded insurance savings. Instead, the assumption is that you’ll save money on premiums and hopefully, things will go well. However, if they don’t, you have the resources to offset the losses.

What are the risks when you self-insure?

The biggest risk of self-insurance is that you could wipe out your life savings when you have to pay for something on your own.

You might not be required to maintain homeowners insurance once your mortgage is paid off, so you could legally decide to self-insure. However, if your home is destroyed, it might cost hundreds of thousands of dollars to rebuild it.

Your home might have cost $150,000 when you bought it 20 years ago, but with inflation, the cost to rebuild it might be $225,000. Without insurance, all of that cost comes out of your own pocket. You might need to borrow or deplete your savings to replace the home.

Another big issue is liability insurance. If someone sues you as the result of an accident for which you’re at fault, and you don’t have insurance, you could end up on the hook for thousands (or even millions) of dollars. Adequate insurance protects your assets from this large cost.

The idea behind insurance is to limit the risk that a large accident, illness or other problem will destroy your finances. You pay a relatively small monthly premium to protect against the unexpected. If something does happen, there’s a good chance your payout will be worth more than all the premiums you paid. However, even if you never file a claim, knowing you have insurance can be worth it for the peace of mind that it provides.

When should you self-insure?

Self-insuring isn’t always a bad idea, even if there are risks. In some cases, self-insurance can make sense. At least, you might be able to do some measure of self-insuring to reduce premium costs while at the same time maintaining some protections. With that being said, it doesn’t always make sense to self-insure.

Car Insurance Coverage

In almost every state, you’re required to maintain liability car insurance at the very least. However, if your car is paid for and it isn’t worth very much, it might make sense to avoid collision insurance. Perhaps your car is only worth $2,500, so you decide to build a car replacement fund and save up money so that you can buy a car for at least $3,000 later. You will still need to pay for liability insurance, but you get a break on premiums by leaving off collision insurance and by planning to cover the cost of replacement or repairs yourself.

Homeowners Insurance Coverage

Given that homes can cost so much to replace, self-insurance might not make sense in this situation instead of a homeowners insurance policy. Additionally, the liability coverage should be adequate in the event that you’re sued for injuries that take place on your property.

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Renters Insurance Coverage

Renters insurance might be a different story, though. Depending on how much your things are worth, self-funded insurance in the form of an emergency fund might be a good choice. You could replace items without too much trouble.

However, consider liability issues, since you might be on the hook for some accidents. Figure out how much you can afford to replace and consider getting insurance for the rest.

Health Insurance Coverage

While health insurance is mandatory under the Affordable Care Act, the penalty has been lifted, so some feel that they can self-insure without paying costly premiums. However, the cost of a hospital visit can run in the tens of thousands of dollars. If you’re not sure that you can save up that amount of money, it might be a better idea to get some type of catastrophic coverage to manage the basics and then self-insure when it comes to more routine healthcare.

Disability Insurance Coverage

If you’re unable to work, it can mean a significant loss of income. Disability insurance can protect against this by offering income replacement. By saving up a large emergency fund, it’s possible to self-insure against this issue. Additionally, you might be able to supplement with Social Security disability benefits if you qualify.

However, if you end up with a long-term disability and your Social Security benefits are inadequate, you might deplete your savings quicker than expected. One solution might be to build an emergency fund designed to handle short-term disabilities or temporary situations while paying for long-term disability insurance. This can be a way to ensure your income is adequately protected while saving money on premiums.

Long-Term Care Insurance

One of the best candidates for self-funded insurance is often long-term care insurance. This type of insurance can be costly, and you might have trouble getting your payout later. By planning ahead and saving up money over time, you could potentially build a nest egg that would provide you with enough income to pay for assisted living or other long-term care.

The earlier you start planning for this type of eventuality, the more likely you are to successfully self-insure.

Life Insurance

If you don’t have dependents relying on your income, you might want to self-insure in this case for life insurance. You can set aside enough to cover the expenses of a funeral and other expenses so that others aren’t on the hook for the costs, and make sure that they know where to access the money.

Additionally, if your children are old enough and you aren’t worried about a spouse to provide for, it can make sense to let a term life insurance policy come to its end without renewing it. As long as those you care for are provided for and your assets can cover your debts, life insurance might not be necessary.

However, life insurance can still be a valuable tool for long-term estate planning and for making sure any dependents or heirs are cared for if you pass.

The Bottom Line About Self Insuring

There are situations when some combination of self-insurance and a more traditional insurance policy can help you save money and still protect your assets. The idea behind insurance is to help you avoid financial ruin if something unexpected happens and you end up with a large expense.

Before you self-insure, double-check to ensure that you can afford the costs of self-funded insurance and your assets are up to the task. It might save you money on premiums, but if you aren’t properly prepared to deal with the big stuff, lack of a traditional insurance could drain your hard-earned resources.

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