Getting an insurance policy typically involves paying a company a premium in exchange for selected coverage types. To financially protect their home or car, some people may choose to keep their coverage bare bones (or buy none at all) and instead set aside money to pay for damage out of pocket in the event of damage from an accident or natural hazard. This method, called self-insurance, may work for some, but it may not be an option if you finance your home or vehicle, and it does come with substantial potential risks.
What is self-insurance?
When you choose to self-insure, you set aside money to cover unexpected events that may impact your home, vehicle or life instead of reaching out to an insurance company to purchase a traditional policy. Self-insurance is an alternative to any type of insurance including home, auto and life, but the legal and financial ramifications of choosing to self insurance are very different depending on the policy type.
The primary perk of self-insuring is that while you are disaster-free, you get to pocket the money you would have paid in insurance premiums. This can end up saving you a lot of money, especially if you don’t incur a financial loss. The major drawback, though, is that when you do face an unexpected loss, the full burden of financially recovering from it falls to you. Depending on the policy type you’re opting out of, this cost could be in the hundreds of thousands of dollars if you needed to, for example, rebuild your home following a total loss or you’re found liable for someone’s injuries after a car accident. Considering that Bankrate’s emergency savings report found that 57 percent of U.S. adults are uncomfortable with the emergency savings they have, self-insurance is not a reasonable financial plan for most drivers.
What are the different types of self-insurance?
Self-insurance can apply to most types of insurance including car, home and life. However, most states have traditional car insurance requirements, and you may be required to purchase a home or auto insurance policy if you finance your car or home. If you are wondering where you might be able to implement self-insurance in your own life, below are some policy types that self-insurance can supplement or replace.
Most states require that drivers carry at least certain minimum levels of liability coverage from an insurance company. But you may be able to explore self-insurance for other components of your car insurance coverage if you decide more coverage is necessary.
For example, if you are concerned about monthly expenses, you could choose to get your liability coverage through a cheap insurance company and self-insure for other protections, like collision and comprehensive coverage. You could set aside money to repair or replace your vehicle if it is damaged. This would mean that, while you have a traditional insurance policy for your liability coverage, you would be self-insuring for the damages to your own vehicle.
This may not be an option for you if you have a loan or lease on your vehicle, as your lender will likely require that you carry full coverage car insurance. It could also be relatively expensive to repair or replace your car, so you may want to compare the level of savings you would need to what you would pay for a traditional car insurance policy in your state.
Homeowners and renters insurance
If you have a mortgage, most lenders require you to carry homeowners insurance. But if you own your home outright, you may be interested in establishing a self-insurance plan.
Repairing damage to your house can be costly, so this option works best if you already have a significant amount in savings. If your home is destroyed and you self-insure, you will likely want to have enough money to pay for the rebuilding costs of your house as well as to replace any of your belongings that were damaged. Most homeowners do not have the disposable income to pay for an expense of this magnitude.
Self-insurance may also be an option for renters. Rather than buying renters insurance, you may choose to self-insure. Instead of paying a monthly, quarterly or annual premium, renters who self-insure instead earmark a certain amount of savings to pay for damages. When the unexpected happens, these renters can tap into those savings to replace their belongings instead of filing a traditional insurance claim. Many landlords require their tenants to have renters insurance, though, so this may not be an option for you.
Additionally, your home and personal property are not the only things covered by a traditional insurance policy. If you self-insure, you should also consider the costs associated with causing damage to someone’s belongings or someone getting hurt on your property. These costs could include medical bills, legal fees and the repair or replacement cost of damaged items. A homeowners or renters insurance policy covers these situations with personal liability coverage, but if you self-insure, the burden of these costs would fall to you.
Insurance for disasters like floods and earthquakes
Homeowners insurance typically excludes damage caused by earthquakes and floods. Rather than adding an endorsement or buying a separate policy to protect your home against these disasters, you may choose to self-insure. Not all states are as prone to earthquakes and floods though, so if you live in an area where earthquakes and floods are very rare, self-insurance may be an option to consider.
You will also want to carefully evaluate your home’s risk for certain disasters. If your home is in a low-risk flood zone or is substantially elevated, for example, flooding may not be a major concern. But if your home is located on a flood plain, you should know that even one inch of water can cause up to $25,000 in damage to your home. If you do not readily have that amount at your disposal for repairs, you may be better served by purchasing a flood insurance policy. Additionally, if you have a mortgage on your home and are in a high-risk area for these disasters, you may be required to have traditional insurance coverage.
You should also be aware that floods can happen anywhere and earthquake risk is moderate to high in a few areas of the country. Just because you live in an area where the risk seems low doesn’t mean it’s guaranteed to never happen.
Life insurance is designed to provide your loved ones with a financial cushion should you pass away, but a traditional life insurance policy may not be the right choice for everyone. Some people choose to self-insure for their life insurance, setting aside money throughout their life that will be left to their loved ones.
There are a lot of factors to consider when it comes to your life insurance, whether you choose to self-insure or purchase a traditional policy. The amount of money you’ll want to leave behind will vary based on your family’s situation. A few things to consider are whether you are the primary source of income in your household, if you care for someone with a disability, and the amount of debt you owe. You’ll want to ensure you save up enough to cover your funeral expenses, replace your salary for your loved ones, pay off debts or leave behind a financial gift.
Is self-insurance right for you?
Generally, a self-insurance plan is best for those with a large pool of readily available assets and exposure to minimal risk. For example, an individual who has significant savings and no debt may choose self-insurance if paying high premiums to insure against the possibility of an unlikely, costly event doesn’t appeal to them. Or a family with a second home may choose to self-insure the second residence, knowing it could sit vacant while they save up for necessary repairs.
As with most financial decisions, self-insurance has advantages and disadvantages.
Advantages of self-insurance
The main perks of self-insurance include:
- Funds availability: In most cases, when you work with an insurance provider, you’ll have to prove your losses. For example, if you get into a car accident, your insurance company will want to inspect your car and evaluate the damage before you can receive any claim payouts. When you self-insure, the money is immediately available to you.
- No policy limits: When you self-insure, you are not subject to any limits of coverage like you could be with traditional insurance. You can choose to save as much as you want or think will be necessary to recover after a loss.
- Flexible fund usage: By self-insuring, you get to decide how your funds are used after a loss, giving you full flexibility to recover in the way you think is best.
- Potential for savings: Self-insurance may give you the opportunity to save money. Without an insurance premium to pay, you could put that money into savings or toward another expense.
- Control over claims: Filing an insurance claim can be time-consuming and complex. With self-insurance you can get damage repaired how you want and on your own timeline.
With fewer limitations on how to recover after a loss and the opportunity to grow your savings, self-insurance may seem like an exciting opportunity. But you should consider the potential drawbacks, too.
Risks of self-insurance
Self-insurance comes with some notable drawbacks, including:
- Planning challenges: A self-insurance plan requires just that: a plan. The most successful self-insurers are those who regularly put money into a dedicated self-insurance account and resist the temptation to use those funds for anything other than covering losses that would have been paid out by an insurance policy.
- Legal ramifications: Your state may have requirements about your car insurance, and your mortgage lender may require a certain level of home insurance. Before you self-insure, make sure you will still be in compliance with requirements that pertain to you.
- Potential for large out-of-pocket expenses: While self-insurance may give you the opportunity to save by not paying insurance premiums, you should be aware that the financial damages from losing your vehicle or home can escalate quickly, sometimes costing tens of thousands dollars or more. Without an insurance policy to help pay for these costs, you will have to pay for damages out of pocket. If you have not saved enough, you could face financial devastation.
- Unpredictability with funds: Because you need to have money available to cover any sort of accident or damage, your money can be locked up for a long period.
Self-insurance, like many financial decisions, is multifaceted and depends on a number of factors. While it may be a good decision for some, it likely does not fit with all scenarios. If you are unsure if self-insurance is right for you, talking to a financial advisor may be beneficial.
Frequently asked questions
In most cases, to self-insure your car, you’ll need to purchase a policy that meets minimum state requirements. Some states allow you to forgo traditional auto insurance coverage if you make a deposit with the department of motor vehicles while others require you to purchase a policy. Once you’ve fulfilled state laws, you can budget and set aside money as you see fit to financially protect your vehicle. This may include money to pay for a potential car crash, damage from a natural disaster, theft or vandalism.
Most states do not allow drivers to self-insure, at least not entirely. Some may allow you to place a deposit with the department of motor vehicles to prove financial responsibility while others require all drivers to carry a minimum coverage policy. Deposits for financial responsibility typically sit around $40,000. New Hampshire is the only state that does not require you to demonstrate financial responsibility or purchase car insurance, unless you’re required to file an SR-22.
Some people consider self-insuring as a way to avoid paying insurance premiums. Generally, though, self-insurance is best for people with a significant amount of assets at their disposal. If you are considering self-insurance because your budget is already tight, there are often other ways to save money. For example, you could get quotes from multiple insurers and switch companies if you find a policy that costs less. You could also consider raising your deductibles, which would reduce your premium without sacrificing your coverage types.
Not necessarily. Almost all states require that drivers buy at least minimum levels of auto liability insurance, for example. Before deciding to self-insure, you may want to confirm that doing so would still meet any requirements that are placed on you, such as requirements imposed by your state or mortgage lender.
The amount you will need to set aside when you self-insure will depend on your specific situation. Self-insurance for life insurance, for example, requires only the amount of money you wish to leave behind for your beneficiaries, while self-insurance for auto insurance requires you to consider the possibility of out-of-pocket expenses in the tens of thousands or even more if you cause substantial harm to another person or their property. In most cases, insurance experts advise that a robust insurance policy is less expensive and less risky than opting for self-insurance. Talking to a financial advisor or insurance agent could help you determine how much you should save if you decide to self-insure.