Can You Self-Insure?


23 June,2014

One of the ways to protect your assets without breaking the bank is to purchase insurance. Insurance policies are designed so that you pay a smaller amount each month in exchange for a larger payout down the road if you need it. The premiums can be frustrating — especially if you go years without the need to make an insurance claim — but in the long run, insurance can provide vital protection to your finances.

Many of us don’t have the money to replace a car or a home at a moment’s notice when disaster strikes. If you didn’t have homeowners insurance, you would be stuck trying to buy a new house or rebuild your old house, even though you might still have other costs to pay. To a lesser degree, this problem applies to buying a car. Even renters insurance can be helpful when you stop to think that it might cost you more than $15,000 to replace the contents of your apartment if you have expensive electronics and furniture.

If you end up in the hospital, chances are that you won’t be able to simply pay the bill; most hospital stays cost much more than you can easily afford. Some things are just too costly for you to be expected to pay for all at once.

However, there are times when it is possible to self-insure. While you might need to purchase insurance policies for some of your bigger assets, it can make sense to use an emergency fund or cash cushion as a way to self-insure.

What Items Should You Self-Insure For?

The first thing you need to do if you expect to successfully self-insure is to build up an emergency fund. You need a stash of cash (or other assets) that you can rely on if needed. If your goal is to self-insure for some things, you need to make building your emergency fund a priority. Whether you keep your emergency fund in a high-yield savings account, or whether you have the risk tolerance to keep your money in a taxable investment account, you need to have something to draw on.

First of all, think about what types of situations you can self-insure for. If you have an old car, you might be able to drop collision and comprehensive coverage if you have enough to buy a new car. (All states require that you purchase auto liability insurance, so you can’t get yourself completely off the hook for car insurance.) Drop what you’re paying in terms of coverage and set the savings aside to further boost your emergency fund in the event that you need to buy a different car.

Other people self-insure for short-term disability. Instead of getting short-term disability insurance, they focus on paying for a long-term disability policy and save up enough to cover what is needed until the long-term disability payout kicks in. This can work well if you have the ability to completely rely on your emergency fund for at least 90 days.

Consider different possibilities. If you are rarely sick, it can make sense to just get a catastrophic health plan to cover emergencies and hospital stays and then pay out of pocket for your rare doctor visits. However, you need to be aware that the new health care law means that not everyone can get away with nothing but catastrophic insurance. Review your needs, though, because a high-deductible plan in conjunction with a Health Savings Account might be a reasonable solution to the situation.

There are those who, instead of purchasing long-term care insurance, build up a nest egg and use a portion of it to purchase an annuity to cover those costs. (Although you do have to be careful about annuities). If you don’t want to pay for long-term care insurance and you have the time to build your wealth so that you don’t have to worry about it, this can be a viable solution, as long as you think things through and make the right decisions for you.

How Big is Your Emergency Fund?

If you plan to self-insure, you need to have a plan for building up enough assets to make it happen. One of the best ways to do this is to automate your finances so that you make regular savings contributions without the need to think about it. This also works well if you have a low-cost investment account with a discount brokerage. I like using Betterment to save for a variety of goals, including things that I might want to self-insure for.

This approach can be satisfying since you get all the benefit of the money that you save up over time. If you purchase an insurance policy and end up not needing insurance, you have paid all those premiums for nothing. However, if you can self-insure for some situations, then all the money is yours (or yours to pass on to your heirs).

While it isn’t practical to expect to self-insure for everything (home, auto, and life insurance are policies that almost everyone should have), you can still take steps to reduce your need for insurance. Look at your situation to decide if there are some items that you can switch up, even if you just reduce your coverage amounts. Find ways to build your assets, and then see if it makes sense to self-insure — at least in some areas. You’ll have peace of mind and get to keep more of your money.