As an alternative to buying insurance on the market or in addition to it, some public authorities and large industrial concerns set aside funds to cover losses from insurance events. Because the risk remains within the organization itself, there is no market transaction for purchase and sale.

These organizations have decided to be insurers of themselves because they believe that they are financially powerful enough to bear such losses themselves and because for them the costs such as transfers to the fund are lower than the market levels of premiums due to the saving of administrative costs. costs and profits of the insurer.

There is a clear line between self-insurance and non-insurance. In the latter case, whether the organization is aware of the risk or not, it does not take any action to protect against possible loss. Perhaps in a large group (for example, a nationalized enterprise or a local administration) many losses can be included in the Income Statement.

Advantages of self-insurance

The advantages of a self-insurance scheme can be summarized as follows:

There are no costs related to the brokerage commission, for administrative expenses or for profit of the insurers;
The income from the fund's investment belongs to the company. It can be used to increase the fund itself or to invest in business expansion;
The plan of the insured to insure the risk is not affected by the history of damages of other companies;
There is a direct incentive to reduce and control the risk of loss;
There will be no disputes with insurers regarding the claims;
As only large companies are likely to decide on self-insurance, they will have qualified risk finance staff to administer the fund.

Disadvantages of self-insurance

The disadvantages of self-insurance are as follows:

Although unlikely, a catastrophic loss could occur that would deplete the fund and likely lead the organization to liquidation if the balance sheet is currently unstable;
Although the organization is able to absorb a single loss, the cumulative effect of several losses in one year could have the same impact as a catastrophic loss, especially in the first years after the creation of the fund;
It may be necessary to increase the number of specialized staff hired, leading to additional costs for the employer.

Technical assistance to insurers or brokers related to risk prevention may be lost. Insurers' servers have more experience with many companies and different industries and this knowledge would be useful for the insured, but now such services will be available for a fee.

The organization's statistics, on the basis of which forecasts are made for future costs related to risk events, are very limited.

Shareholders and analysts may be critical of:

the transfer of huge capital for the establishment of the fund and the loss of dividends for the same year;
the low return on investment of the fund compared to the return that could be obtained if this capital was invested in the production sphere of the organization.

During financial tensions, the temptation to borrow funds from the fund may arise, thus destroying the security it has created.

Fund managers may pay losses that are outside the insurance coverage, which can lead to a reduction of the fund and thus complicate the analysis.

The basic insurance principle, namely the distribution of risk, is not used.

Contributions made to the fund may not benefit from tax relief, while premiums paid to insurers (including captive companies) typically benefit from such relief.

It is for these reasons that the whole range of newer products for alternative risk financing has been created. They allow a company not to buy traditional insurance products and still not have to face all the costs and pitfalls of self-insurance.

Source: David E. Bland "Insurance: Principles and Practice"

Self-insurance