Consider Self-Insurance Against Calamities

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Burning BMWLast week, as I was research the “catch” on a return of premium life insurance policy, I wondered if it was possible for you to self-insure your life. The idea behind self insuring is that you take a lower level of insurance protection and save the difference into an account. With auto insurance, you could take away comprehensive insurance coverage, rental car coverage, or raise your deductible and put the savings into a high interest savings account.

I do this today with my auto insurance. For my Acura Integra, I didn’t carry comprehensive insurance and was able to saving hundreds of dollars a year. When it was totaled, through no fault of my own, I rolled the savings over to do the same thing with my current car, a Toyota Celica. As I’ve gotten older and the premium on excluding comprehensive insurance decreases, I’m tempted to add comprehensive again and pay for it with the fund. I’m able to because of good driving and good fortune, but I think that self-insurance is something everyone should consider.

The General Idea

The general idea behind self-insuring is that you want to reduce your level of coverage and put the difference in savings. The obvious benefit of this is that by having the difference in savings, you earn interest. The not so obvious benefit is that when the more dangerous accumulation period is over, that is the time it takes for your savings to grow large enough to cover potential problems, the benefits accelerate.

It’s like buying a car (self-insuring) and leasing a car (not self-insuring). The first few years of ownership or leasing are pretty much a wash, which is why leasing is appealing to businesses. However, there comes a point several years down the road where the car is basically “free,” excluding some maintenance, after you pay off the car loan. I see self-insurance in the same way, as long as you can avoid calamities for the dangerous accumulation period, you can get ahead by self-insuring where it makes sense.

Where this makes most sense is where the potential catastrophes are relatively small, to whatever benchmark you feel comfortable with (net worth, savings, etc.), and the savings you could get by downgrading coverage is great. There aren’t many cases where this is possible but there are a few notable ones.

Auto Insurance

This example is cleanest with auto insurance because it’s easy to see the savings. If you’re able to save $50 a month by raising your deductible from $500 to $1000, then after ten months you’ll have saved enough to cover the difference in the event of an accident. In this case, by raising your deductible you are exposing yourself to $500 of risk. If you can save $50 a month, then the accumulation period is 10 months… so avoid accidents for 10 months. 🙂

On auto insurance, like with many insurances, you have a lot of options:

  • Comprehensive insurance
  • Rental car coverage
  • Deductibles

Homeowners Insurance

With homeowners you may be required by your mortgage lender to keep a certain level of insurance coverage but you may have options picking the deductible you want. Again, like auto insurance, compare the prices to see if it makes sense for you to increase the deductible and put the savings away to cover potential problems.

I’m hesitant to offer up removing flood insurance and guesstimating how much it would cost to repair “typical” flood damage, though those riders are certainly worth considering.

Life Insurance

Is this possible with life insurance? This is really the scenario that prompted this post in the first place. When I started thinking about it, what are we really insuring against? Ultimately I settled on the idea that life insurance exists to do one of two things:

  • Insure against a future income stream – this risk is most obvious for a single income family where the death of the breadwinner really puts the family in a bind. If the spouse hasn’t worked in a long time, it’ll be difficult, especially now, it won’t be easy restarting.
  • Insure against current debts – this is the risk that probably affects more families and it’s because of the mortgage. If either spouse dies, the survivor is still responsible for the debt. If it’s the breadwinner who dies, that makes the situation even worse because you have both the loss of income and the demands of a loan.

I ran some numbers and it doesn’t seem feasible to self-insure for this sort of thing. If you assume 8% APY on your savings, which puts it into investing terrible (rather than savings account territory), you need to save $71 a month to reach $100,000 in thirty years. $213 a month if you want to reach $300,000. If those issues are concerns for you, I don’t think self-insuring makes financial sense.

Final Thoughts

Remember that you’re up against actuaries, with years of training and tons of statistical data, so self-insurance can be a risky proposition. Even if you’ve had a lifetime of safe driving, you never know when you’ll run into a string of bad luck that saps your self-insurance fund of all its money. It takes a certain time of person, who isn’t afraid of assuming this level of risk, and careful financial calculation.

Do you self-insure? If so, what do you self-insure?

(Photo: ej_imageries)

{ 18 comments, please add your thoughts now! }

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18 Responses to “Consider Self-Insurance Against Calamities”

  1. Glenn Lasher says:

    For life insurance, you actually need to turn the idea on its head. Good term insurance will get you a lot of bang for the buck. In the event of the unfortunate, you can easily be carrying enough insurance that your survivors can invest the benefit and approximately replace your income. You need to have that cover you until retirement, when you were planning on doing without that income anyway.

    • TheMadTurtle says:

      Yup! Since the birth of my son, I’ve taken out a hefty term policy on myself for that very reason. I’m the sole breadwinner, so the insurance would give my wife and son enough to live on with just the interest. Later, they can use some of the principle to pay for college or something.

  2. I definitely see the benefit in saving money on car insurance by raising the deductible and dropping comprehensive. There are probably so many instances of old cars that should not have comprehensive coverage. People are paying a ton in insurance costs, when the insurance company would not pay that much for the vehicle.

    • Shirley says:

      At $715 per 6 months for full coverage on 3 cars (1995-2000) the savings would take longer to even out than we will probably be driving. 🙂

  3. An investment portfolio.

    By using conservative option strategies, you can protect yourself against a disaster.

    Glad you asked.

  4. Brandon says:

    I have a 2000 and 2006 car insured with GEICO. For fun I tested changing my current deductible for collision from $100 to $1000. It saved a total of $79.80 over 6 months which calculated out would take 5 years 7 months to recoup in self-insurance. If I raised comprehensive to the same level from the same level it would increase to a little over $100 savings for only a 50 month recovery time.

    The only real savings to be had would be if I completely removed collision, comprehensive, emergency road side assistance, and rental reimbursement from my older car. That would save $136.30 per 6 month period. The KBB private party value is $2,485 which would take 109 months to save up.

    In summary, I have seriously cheap auto insurance through GEICO. $605.10 6 month premium for two cars with 50000/100000 bodily liability coverage and similar coverages for other levels along with $100 deductibles for comprehensive and collision, Emergency Roadside Service on one vehicle (the other has it as part of an extended warranty) and Rental Reimbursement.

  5. Brandon says:

    Actually, thanks for posting this. I noticed my medical payments coverage was only $1,000 per person for at-fault accidents and because of a recent experience, I now know even the most benign emergency room visit easily will cost $1,250+ before insurance. I increased the coverage to $5,000 for only $3.02 per month (it will take 110 years before this change could be self insured at that rate for even one person in one accident)

  6. Fred says:

    This is the basic concept behind Health Savings Accounts (HSAs), and its a great one.

    Another positive aspect of self-insuring the initial loss is that it makes smarter consumers.

    Let’s say you get into a car accident and need repairs. With some effort, you could find a carpool to/from work for 2 weeks while the repairs or made, or you could spring for a rental car @ $30/day or more.

    If *you’re* paying the $30/day, carpooling starts to sound pretty good, even if you do “have the money” saved already for it. If the insurance company is providing the car, there’s little incentive not to take it.

    But, as with so many things, self-insurance requires on-going self-discipline. HSAs help with this because they put the funds out of reach, but they still make them available if you absolutely need them.

    • Jim says:

      It does require self-discipline but if you want to save money, you have to pay for it somehow and extra work is the easiest/quickest way.

  7. jsbrendog says:

    this is an interesting idea. I like it for car insurance. maybe I will try it out once I get my car

  8. aua868s says:

    have been avoiding life insurance…its time i got one

  9. eric says:

    This is a good topic. I love the car insurance idea and that’s something I’m doing also.

  10. Michael says:

    If you have a good driving record, I would suggest Amica for car insurance. They dont insure “High Risk” users, so if you have a ticket or accident in the past 3 years, you may be denied. At 23, no accidents for 3 years and a policy of 100/200/100 with a 500$ deductible, its only 900$ a year(of course PIP and everything else required by the state of Florida). Furthermore, as many may know, insurance companies generally do a 6 month policy. They will tease you with a low rate for the first 6 months and yank it up on renewal. Amica is one of the few insurance companies that does a 1 year contract. Lets just say, i am very happy with my insurance company.

  11. Hey Jim, I think you have a great srategy for evaluating when to self insure and when to insure through an insurance company. I think its a great idea for people who are not real risk averse to practice using higher deductibles and saving the difference. I would wager that insurance companies have much lower claims with clients who practice this method.

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