What does it mean to self-insure — and should I do it?

Key points

• Self-insurance means acting as your own insurance company to cover your own losses.
• There are ways to apply the self-insurance model to home, life, health and auto insurance.
• If you underestimate risk when self-insuring, you may have to pay more than you have saved.

Typically, you purchase insurance coverage from an insurer and that party pays for your health, home or auto insurance. But there is another option called self-insurance.

When you self-insure, you don’t purchase insurance coverage. Instead, you set money aside to be used in the event of an incident.

This sounds risky, and you might have questions. Read on to discover if it’s legally allowed and when to consider self-insurance.

What does it mean to self-insure?

With self-insurance, you act as your own insurer. Rather than purchase a policy and pay the monthly premiums, you set aside money to pay out of pocket for losses.

For instance, let’s say you decide to self-insure for car insurance, which is an option for residents of New Hampshire. If you got into a fender bender, you would have to pay out of pocket to fix your car rather than file a claim with the insurance company.

Self-insuring can also mean knowingly choosing a low level of insurance so you don’t have to pay a high premium, sort of like ordering a la carte. You would purchase certain coverages from an insurer, then self-insure in other areas. If you have an old car with a low Kelley Blue Book value, you might drop collision auto insurance coverage and self-insure against a collision, for instance.

What are the risks of self-insuring?

If you are a primary breadwinner with dependents, and you don’t have life insurance, “you’re rolling the dice if you have people that are financially dependent on you,” said Jason Veirs, the president and owner of Insurance Experts Solutions, Inc. “If there are no funds around if a primary income earner passes away, the descendants are in a bad place.”

A second risk of self-insuring is not having enough money to cover losses. For example, if you cause a head-on collision that injures the other motorist and totals your car, you may not have the money to pay associated medical costs and get a new car.

Pros and cons of self-insuring

When you self-insure, you keep more money in your pocket because you don’t have to pay insurance premiums. Once you build up that nest egg, you can maintain it as long as you don’t experience losses, such as auto accidents.

The downside of self-insuring is the risk and uncertainty of a potential loss. If you suffer a larger than anticipated loss or a series of smaller losses, such as multiple auto accidents in one year, your nest egg could be depleted.

Large or repeat losses are difficult to predict and tough to self-insure against. Many people decide they’d rather pay for insurance for the peace of mind it provides.

It’s worth mentioning that if you decide to self-insure for life insurance without a full understanding of the risks, you risk passing the losses on to your dependents. “Moving out of a house, not being able to pay a mortgage, not being able to sustain a quality of life that [they’re] used to,” said Viers of potential consequences for surviving dependents.

Pros

• Pocket what you normally pay for insurance premiums.
• Self-insure partially or fully, up to your appetite for risk.

Cons

• Accidents or losses could deplete your premium savings or, worse, put your finances (and dependents) in bad shape.
• It’s not legal to self-insure in every scenario (like when you have a mortgage) or every state (most require auto insurance).

Examples of self-insurance

To help you understand whether self-insurance is an option for you, let’s consider examples:

• Health: You purchase a high-deductible health insurance plan. Your monthly premiums are low, and you self-pay for care until the deductible is met, perhaps by using a health savings account that allows you to make pre-tax contributions.
• Car: You drop optional coverage elements like collision and pay out of pocket in the event of an accident. If you live in a state where car insurance is optional, you decline coverage and assume all financial risks.
• Home: Since mortgage lenders require home insurance, it isn’t really an option to self-insure while you have a mortgage. As soon as your mortgage is paid off, though, you cancel home insurance and self-insure for incidents, such as roof damage. 
• Life: Rather than buy a $500,000 life insurance policy, you amass an investment portfolio worth $500,000 to support your loved ones if you die.

Is self-insurance something I should consider?

It isn’t for everyone. For example, Viers pointed to a friend who is a high-income earner and perpetual bachelor. He can self-insure because he has no dependents and enough money set aside to pay for care if something went wrong. 

But consider this scenario: If a dual-income household was self-insuring, and the primary income earner was hurt, you could be relying on a GoFundMe to cover setbacks if the loss was greater than budgeted for, Viers said. 

Therefore, self-insurance could be a good option those who:

• Have no dependents.
• Are nearing retirement. 
• Have paid off the mortgage and have a “sufficient nest egg” to cover losses.

Frequently asked questions (FAQs)