Self-insurance: Overview, definition, and example
What is self-insurance?
Self-insurance is when a business or individual sets aside funds to cover potential losses instead of purchasing traditional insurance from an external provider. Rather than paying premiums to an insurance company, the business or individual assumes financial responsibility for covering risks such as property damage, employee health benefits, or liability claims.
For example, a large corporation might choose to self-insure its employee healthcare program by paying medical claims directly instead of buying a group health insurance policy from an insurer.
Why is self-insurance important?
Self-insurance can help businesses save money by avoiding high insurance premiums, especially if claims are low. It also provides more flexibility in managing risks, claims, and payouts. However, it requires careful financial planning to ensure that sufficient funds are available to cover unexpected losses.
For example, a construction company might set aside a reserve fund to cover potential workplace injury claims instead of purchasing workers' compensation insurance. This can reduce costs over time but also carries the risk of significant financial exposure if claims exceed the reserved amount.
Understanding self-insurance through an example
Imagine a mid-sized business with 500 employees. Instead of purchasing traditional health insurance, the company decides to self-insure its employee healthcare program. It sets up a dedicated fund and pays employees' medical expenses as they arise.
- If an employee visits the doctor and incurs a $200 bill, the company pays it directly from the fund.
- If a serious illness requires a $50,000 treatment, the company must have enough in reserves to cover it.
To manage financial risks, the company may also purchase stop-loss insurance, which provides coverage if claims exceed a certain amount.
Another example is a retail company that self-insures its fleet of delivery vehicles. Instead of paying premiums to an insurance company, it maintains a fund to cover accident repairs and liability claims. If a minor accident costs $3,000 to repair, the company pays directly from its fund, avoiding insurer markups and claims processing delays.
An example of a self-insurance clause
Here’s how a contract might define self-insurance:
“The Company may elect to self-insure any risks related to its operations, provided that it maintains adequate financial reserves to cover potential claims. The Company shall remain responsible for all liabilities arising from self-insured risks.”
Conclusion
Self-insurance allows businesses to manage risks independently, reducing costs and providing greater flexibility. However, it also requires careful financial planning to ensure that sufficient funds are available to cover potential claims. Companies that choose self-insurance must evaluate their risk exposure and ensure they have the resources to handle unexpected losses.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.