Self insuring small risks

In short

A friend of mine once paid $180 a year to insure a $400 phone, and he never filed a single claim. If you have ever stood at a store counter while a clerk offered you an extended warranty, you know the pitch. Self insuring means you cover a small loss from your own savings instead of paying a company to cover it. It works best when the loss is small enough that one bad day will not hurt you. It works badly when the loss could wreck your finances. Start by listing the policies you carry and the size of each deductible. Then ask whether a cash cushion could pay that amount tomorrow. Done carefully, this can save real money. Done carelessly, it can cost a great deal.

The whole of it

What it is

I once watched a neighbor pay a $1,000 deductible after a hailstorm and then say, plain as day, that he had been paying for the wrong kind of coverage all those years. His point was a fair one. Insurance is a trade. You pay a small, certain amount each year, and a company promises to cover a large, uncertain loss. Self insuring means you decide to keep some of that risk yourself. You set money aside and pay the small bills out of pocket.

You have probably done a little of this already. Anyone who skips the warranty on a toaster is self insuring. Anyone who picks a higher deductible on a car policy is doing it too. The idea is not strange or reckless. It is just a choice about who carries a risk, you or the company. A company has to cover its costs and earn a profit, so over many policies it collects more than it pays out. That gap is the price of the service. The question for you is whether the service is worth the price for a loss you could handle anyway.

How it works

If you are holding a policy right now, find the page that lists the deductible. The deductible is the amount the policyholder pays before the insurer pays anything. Raising it usually lowers the premium, which is the bill for the coverage. Your insurer will quote you both numbers, and that quote is where the real math begins.

Here is the logic in plain terms. A higher deductible means you take on more small losses yourself. In return, the insurer charges less. If you keep the savings in a reserve account, that account grows to meet the larger deductible. After a few quiet years, the savings may cover a loss with room to spare. That is the whole engine. You trade a little more exposure for a lower yearly bill, and you build the cushion that makes the trade safe.

Two things have to be true for this to work. The first is that the loss must be small relative to your savings. The second is that the cushion must really exist, in cash you can reach in days, not in an account that is tied up. Without both, you are not self insuring. You are just going uninsured, and that is a different thing entirely.

The numbers, and where to find yours

You have likely never looked at your own numbers side by side, so start there. Pull out your declarations page. That is the summary sheet your insurer sends at each renewal. It lists your premium, your deductible, and your coverage limits. Ask the insurer for quotes at two or three deductible levels, so you can see what each step saves.

Some limits are set by law, and they change. For a health plan with a high deductible, the rules on savings accounts depend on yearly figures. The self only contribution limit for a health savings account is the current figure, which the official source publishes each year. The family limit is the current figure, which the official source publishes each year. The minimum deductible a plan must have to qualify is the current figure, which the official source publishes each year. The Internal Revenue Service publishes these each year, and the site fills in the verified figure above with its source and date. Check the date before you rely on any of them.

For car and home policies, the numbers live in your own paperwork. Your state insurance department also publishes consumer guides. Many states require a minimum level of liability coverage on a car. Self insuring does not touch that rule. The borrower with a car loan will often find the lender requires coverage as well. In that case, the lender sets the floor, and you cannot skip it.

A worked example

Let me tell you about a woman I will call Dolores Weaver, a made up neighbor who stands in for many of us. She is forty one, drives a ten year old sedan, and keeps $9,000 in a savings account. Her car policy has a $500 deductible and costs $1,320 a year. Her insurer quotes the same coverage with a $1,000 deductible at $1,140 a year.

First, find the yearly savings. $1,320 minus $1,140 is $180 a year. Next, find the extra risk she takes on. $1,000 minus $500 is $500 more out of her own pocket if she files a claim. Now she can see the trade. She gives up $500 of protection on a bad day and gains $180 every year she has no claim.

How long until the savings cover the extra risk? $500 divided by $180 is about 2.8 years. So if Dolores goes three years without a claim, the savings have paid for the higher deductible. She sets aside the $180 each year in her savings account. After three years, that is $540, and she is ahead.

Her $9,000 cushion is far larger than a $1,000 deductible. A $1,000 bill would take about 11 percent of it, since $1,000 divided by $9,000 is 0.111. That is a bump, not a disaster. So the move fits her situation. If her savings were only $600, the same move would be a bad idea. The deductible would be bigger than her cushion. She would be exposed.

Notice what Dolores Weaver did not do. She did not drop her coverage. She did not touch the part of her policy that protects her from a big lawsuit. She only changed the small, early slice of the loss. That is the heart of it. Keep the big risks insured, and carry the small ones yourself.

Where it goes wrong

I have seen good people get this wrong, and it was never because they were foolish. It was because the downside hid behind a good year. The first danger is a thin cushion. If your savings could not pay the deductible tomorrow, a higher deductible is a trap. Rule of thumb aside, the check is simple. Could you write the check today without borrowing?

The second danger is mixing up small and large. A cracked phone screen is small. A house fire is large. A hospital stay is large. Self insuring works for the first kind. It does not work for the second. Never treat a large, rare loss as if it were small just because it has not happened yet.

The third danger is forgetting the money is spoken for. Many people say they will self insure and then spend the cushion on something else. The reserve has to stay a reserve. Keep it in a separate account with a clear name, and leave it alone.

The fourth danger is a binding rule. A lender may require coverage. A state may require a minimum. A landlord may require renters coverage. In each case, the policyholder has no choice, and the contract controls. Read the paperwork before you change anything. Last, mind your health plan. A high deductible there can bring a hard bill in a bad year, even with the savings account to help.

Questions to answer before you leave this page

If a loss of $1,000 landed on you next week, could you pay it from cash without borrowing a dime? Do you know the deductible on each policy you carry, and what the next step up would save you in a year? Have you asked your insurer for quotes at more than one deductible, so you are comparing real numbers and not guesses? Is the money you plan to set aside sitting in an account you can reach in a few days, and is it kept apart from the money you spend? Does any lender, landlord, or state rule require coverage you were thinking of dropping? Which of your risks are small enough to carry, and which ones are so large that you would rather pay someone else to hold them?