Businesses face constantly rising business insurance premiums. Health care premiums alone have doubled since 2008 according to some statistics. Since the attacks of 9/11, and seasons of unprecedented hurricane and storm activity, insurers have raised business insurance premiums while reducing available coverages.
One option for a business is to participate in a self-insurance program or insure its own risk. Here we answer some basic questions about self-insurance as a part of a business insurance plan.
Self-insurance is a way for a business to lower ongoing premium expenditures and to take control of low-level risks within the organization. This is achieved by the business becoming its own insurer. This can be for a certain level of risk or a certain type of risk. The business creates a fund of money and manages the fund and any claims asserted.
For example, a car dealership with a service center may identify that the largest risk it faces working on a customer's car is a complete destruction of that car. The dealership looks into liability insurance for such a risk and finds the premiums too high or the limits to be too high for the risk. The dealership concludes that $50,000 would be the amount of one catastrophic claim if one of the mechanics makes a major mistake. It also concludes that the risk of this happening is very low. Rather than pay additional premiums for this coverage, the dealership creates a fund of $50,000, puts the money in the bank and earns interest. In the event the unthinkable happens and a Lexus is destroyed by a mechanic, the fund is there to cover the loss.
The above is an extremely simplistic example. Also, I am using a small business as a model and that is perhaps not a good example. This is because - regardless of online pitch hype or purported offshore schemes - self-insurance only makes sense, in most instances, for very large businesses and for very specific risks.
For example, in the state of Michigan, if you wanted to self-insure your automobile risk the state requires the business to own or operate 25 or more vehicles, possess a net worth of over $5 million, and sets a very high fund limit. In most instances, being self-insured is for large companies, with many employees, vehicles, locations, and net worth.
Some risks cannot be self-insured without being approved by your state. Workers' Compensation can be self-insured, but requires approval and the meeting of certain guidelines. Mandatory auto liability insurance can be self-insured only by meeting state requirements. Federal regulations allow the formation of risk retention groups under specific guidelines.
But, for enterprises that are large enough, self-insurance planning as part of an overall risk plan makes great sense. Why pay an insurer when you can pay yourself? Plus, in most instances the company is not insuring the entire risk. Instead it is self-insuring a portion of the risk.
Here is how:
- The business looks at each category of risk and determines what the maximum amount of any one loss that the business can sustain is - that amount is the self-insured retention (SIR) limit. The business retains this amount of risk and covers all losses under this threshold. For example, a company with a $1 million SIR, hit with a $870,000 claim would pay that claim out of SIR.
- But the fund must also absorb a number of smaller claims over time. The business (typically with the help of an expert or accountant) determines the maximum amount of the usual and expected accumulated losses within the self-insured retention in any given policy period. This is called the loss fund limit.
- Depending on accounting rules and application of tax laws to the business, funding this insurance fund and the insurance fund itself are listed as business liabilities for tax purposes. This can result in some tax benefits.
- The business might not fully fund these limits immediately, but may increase the fund over time. Similar to insurance premiums, except the business is paying itself. The fund would also reside in interest bearing accounts earning interest for the business.
- The business then purchases a specific excess policy. Any amount of a claim over the self-insured retention is paid under the specific excess policy. A specific excess policy, because it does not cover the amount of the SIR, is substantially cheaper than a traditional policy with first dollar coverage. Think of this in the same way that higher deductible policies are cheaper.
- If instead of one or two large claims hitting, the company experiences a high volume of smaller claims, the company guards against this with aggregate excess insurance. This insurance provides coverage above the loss fund limits and protects the insured from an abnormal frequency of losses. Again, because it is not first dollar coverage, the policy is substantially cheaper than a traditional policy.
- The business will also manage the claims that occur within the SIR. Under a traditional policy, claims are "turned over" to the insurance company, but under a self-insured plan, the business handles the claims either internally or through a third-party administrator.
Self-insurance can lead to significant savings. Also, you as the business owner maintain the right to fight or deny smaller claims that your insurer would simply pay without consultation. The business can control what legal team is used in the event of a law suit. And their are other benefits, but those would need to be explored with your insurance professional. Most large commercial insurers off self-insured plans and offer services to help administer those plans. For example, The Hartford has information online regarding its self-insured plans for business.