Insurance is often a necessity—an expensive necessity. Car insurance averages $1,718 annually for full coverage, health insurance can cost more than $1,000 a month depending on your age and circumstances, and home insurance averages about $2,000 a year. Protecting what you have, from your possessions to your health, just keeps getting more and more expensive—and not all insurance is worth having.
That doesn’t mean insurance is a scam—no matter how high those premiums might seem, when a claim gets paid it can save you from financial disaster. The flood insurance on my house is pretty expensive, but when the floods came a few years ago the insurance settlement saved our butts and enabled us to rebuild and replace, for example. But sometimes it makes more sense to self-insure than pay for a policy.
Self-insurance
Self-insurance is a simple concept: Instead of buying a policy from an insurer, you safeguard against future problems by setting aside money on your own to cover the associated costs. For example, if you’ve paid off your mortgage and don’t want to pay homeowners insurance premiums anymore, you could put sufficient funds aside to cover the potential costs of repairing or replacing your home after future disaster.
You’re already self-insuring stuff without realizing it—everything you own that isn’t covered by an insurance policy is essentially self-insured. If you bought an expensive television yesterday and it’s not covered by an explicit insurance policy, if it gets stolen tomorrow you’ll have to pay for its replacement from your own pocket. That’s self-insurance. You can self-insure anything to a lesser or greater extent. If you don’t have health insurance, you’re self-insuring yourself. If you’re required to carry liability insurance on your vehicle but opt not to pay for collision or theft insurance, you’re self-insuring those aspects of your car.
The main benefit of self-insurance is that you can keep the money you would normally spend on premiums and let it accumulate, preferably in an interest-earning account somewhere. If a problem arises, you have the money to deal with it. If you never experience a problem, that money is still yours, as opposed to insurance premiums for a policy that never paid out.
When to self-insure
Self-insurance is tempting because in theory you keep your money but also have a plan in place to handle unexpected problems. But unless you have significant liquid funds to draw on, it’s only a good idea in some specific scenarios. For example, let’s say your flood insurance premiums cost $1,000 a year. You drop your policy and put the money into investments instead, where you get a 10% average return, and after 10 years you have about $16,000. That’s great! The bad news is that the average claim paid by the National Flood Insurance Program is more than $66,000, meaning you might be $50,000 short if your house floods. Paying the annual premium is a much better deal in this scenario unless you never need to make a claim—which is a bit of a gamble.
That means there are two basic scenarios where self-insuring makes sense: when the cost of replacement or paying for services is within your means (e.g., you have $66,000 sitting around earning interest somewhere you can set aside for flood damage), or when the item you’re insuring isn’t worth much, making the cost of insurance a bad bet.
There are some specific scenarios where you should definitely consider self-insuring:
Car insurance. Most states require you to carry liability insurance, but more comprehensive coverage is usually up to you. If your car is old and isn’t worth much, and/or you have the ability to do repairs yourself, opting to self-insure the vehicle can make sense.
Jewelry. Like a car, most jewelry plummets in value the moment you buy it, which makes insuring the stuff a bad deal in most cases. Most homeowners insurance covers jewelry to a very limited amount—about $1,500 to $2,000—so if your jewelry isn’t worth much more than that, it makes sense to just self-insure it.
Life insurance. The sole purpose of life insurance is to ensure your family isn’t left penniless if you die unexpectedly. If you have accumulated significant assets that provide an income without a salary, or your family simply won’t need your income (because your children are grown and your spouse has access to shared retirement savings, for example), then life insurance is probably an unnecessary expense and self-insuring is a better idea.
One thing to consider in these scenarios is that the “significant assets” part where you can cover unexpected losses without insurance need to be liquid assets. If your net worth is tied up in property or businesses, for example, self-insuring might require you to sell off those assets, which might not be a pleasant experience. But if you have those liquid assets and you know you can cover the expenses that come with negative events, self-insurance can be a viable option that can save you a lot of money over time.