Self-Insurance: Is it something my business should be considering?

As you review your company’s expenses, you may have found yourself glancing at your insurance premiums. Maybe it has been a while since you have had to file a claim or maybe you don’t feel like your insurance coverage has come through the way you expected when an incident did occur. Either way, you may be wondering about the value you are getting from paying your premiums. Some companies choose to avoid going through a third party to insure against their risk — instead deciding to self-insure. Is this an option for your organization? Maybe, maybe not. In order to determine if self-insurance could work for you, it’s important to understand it a bit more.

Self-Insurance: What is it?

At a fundamental level, self-insurance is exactly what it sounds like. A self-insured company insures itself. Instead of transferring your risk to a carrier, you retain the risk within the organization and ensure that you are able to cover it. Generally this means that funds are set aside for losses a company is at risk for. Instead of paying premiums, money would be set aside that is only touched under the predefined conditions. The most common forms of self-insurance are a general loss fund, a savings account, or a ‘rainy-day’ fund. Why do companies choose to self-insure? There are several reasons that come into play:

• Saving money: By not going through a third-party, you cut out the excess they charge to keep their lights on.
• Understanding risk: keeping insurance internal allows access to all your data, which can lead to a better understanding of risk.
• Customizable Coverage: If a company insures itself, they eliminate the possibility of risks that a carrier would not or could not cover.

Self-insurance is not limited to a rudimentary savings account. A version of self-insurance available to businesses is to create captive insurance. While at its core, captive insurance is still a means for a company to insure itself against future losses, it is much more formal. Captive insurance requires a company to create its own insurance company. There are several benefits to creating a captive insurance company:

• Customizable: As previously mentioned, a captive insurance company can create custom policies and coverages that fill the gaps that a commercial insurance carrier might have.
• Financial Benefits: Companies pay premiums to their captive insurance company, but they come with significant tax benefits and can be used in a variety of ways.
• Partnerships: Unlike a fully self-insured organization, a captive insurance company can pool the risk of several like-minded companies who want to partner together.

While there are several benefits to self-insuring, it is important to note that it is a complex process. If you are considering captive insurance, this is even more true. Setting up an insurance company requires knowledge of both your organization, the insurance industry, and the legal specifics involved. It is also important to have a deep knowledge of your risk, and what coverage you need in place. One of the biggest drawbacks to self-insurance is the potential that your organization does not have an accurate understanding of the risk it faces. So who is self-insuring? Should you?

Self-Insurance: Who’s doing it?

Self-Insurance is actually a very mainstream practice. It is most common in the health insurance sector, especially among large businesses. According to a study conducted in 2015 by the Employee Benefits Research Institute, 78.5% of businesses with over 500 employees were self-insuring at least one of their health insurance plans. [1] Big businesses have two advantages when it comes to self-insuring.

• More resources: Large companies often have the capacity to hire a benefits team to properly analyze risk, structure plans, and manage claims. The administrative costs of a captive insurance arrangement are relatively low impact when compared to a smaller company.
• More employees: Much like a commercial carrier transfers risk by spreading it across a large number of people, big companies have the advantage of a larger pool of employees to spread their risk across.

Self-insurance may be dominant among large businesses, but small and medium companies are getting involved as well. The EBRI study found that among small companies (less than 100 employees) 17.4% were self-insured, while 29.2% of medium-sized companies (between 100 and 500 employees) took advantage of a self-insured structure. [2] While self-insurance is an option for companies of all sizes, it is important to take note of several findings from the study.

• Savings were often not as high as expected. Self-insurance options need to be planned and managed effectively. The cost of running self-insurance plans often exceeded expectations, and erased much of the expected savings of switching away from commercial insurance.
• Company performance mattered. The study found that only top-performing organizations were able to contain the costs and effectively plan out their insurance. It also required them to have multi-discipline expertise, often having to evaluate and internally promote alternative coverage options to keep their costs in check.

It quickly becomes clear that self-insurance is a little more complex than simply setting money aside to cover losses and while it can be an option for companies of a variety of sizes, is it a good option for you?

Self-Insurance: Is it for you?

Commercial insurance can be expensive. And while there are ways to reduce your premiums substantially, the potential savings of self-insuring may have caught your interest. Before you go cancel your policies, there are quite a few things to consider.

Investment Impact on the Organization

Self-insurance requires some financial investment to get off the ground. Some of your potential costs include: establishing a loss fund, setting up administrators to deal with claims, establishing loss control, paying legal expenses, and any excess insurance. Your costs shouldn’t outweigh On top of the financial investment, setting up self-insurance will require substantial time investment from management. Carefully consider the impact that reallocating these resources would have on organizational goals.

Business and Risk Type

Different types of Businesses face unique risks. Some organizations face irregular but high severity losses. Others have high frequency losses but they are more regular in size. Self-insurance tends to be a better fit with organizations that have a predictable pattern to their losses. Predictable losses are easier for a self-insurer to plan for and reduce the need for a commercial insurance partner.

Is Excess Insurance Available?

A key element in any self-insurance plan is the purchase of excess or stop-loss insurance. This insurance is a fail-safe for any unexpected claims, whether they are larger than usual or more frequent. The market pricing of appropriate coverage can differ, and it is important to determine whether pricing is at an acceptable level. If the pricing is too steep, your organization will be missing a fundamental element of self-insurance.

Your Appetite for Risk

While a properly configured self-insurance plan does its best to ensure appropriate financial risk levels, there is still a risk that your organization could have a higher total cost than if you had remained commercially insured. It is important that an organization has an accurate understanding of the risk involved and ensures that potential losses will not have a drastic negative impact on their organization.

Your Long-Term Goals

Self-Insurance is not a short term saving solution. There are substantial set-up costs and the savings from the plan tend to be realized over a longer period of time. Even with proper cost control and risk management strategies in place, it can take some time before these measures actually yield results. If your company is in it for the long run, and willing to work on enhancing your loss and safety record over time, self-insurance could be an ideal platform for you. However, if you are simply looking for short-term savings, this is not the place to get it.

How to Make the Decision

Self-insurance is not simple, and it is certainly not a quick fix. However, if you still think that your company could benefit from self-insurance after understanding the pros and cons and the considerations involved, then it may be time to consider implementation. There are several steps involved:

• Risk Assessment
• Planning for Adequate Coverage
• Internal Communication
• Establishing Loss Fund or Creating a Captive Insurance
• Purchasing Stop-Loss Insurance
• Creating on-going risk assessment and claims administration plan

It is important to begin the self-insurance journey on a strong foundation. Many smaller organizations benefit from partnering with a third-party administrator that can help with initial setup. Here at Ledgestone we bring insurance and risk management expertise to the table, along with guidance on long-term organizational health and growth. If you are interested in self-insurance, or simply want to get a better understanding of your risk portfolio and how to achieve your long term goals, our team would love to learn more about you and your organization. Follow the link below to reach out to one of our experts.

References

1. Dubois, L. How to Budget for Business Insurance. Inc.com. November 30, 2010. https://www.inc.com/guides/2010/10/how-to-budget-for-business-insurance.html.
2. Fronstin, P. Self-Insured Health Plans: Recent Trends by Firm Size, 1996‒2018. EBRI. 2019