Legal Definitions - self-insurance

Self-insurance is a financial strategy where an individual or organization chooses to bear the risk of potential financial loss themselves, rather than transferring that risk to an insurance company by paying premiums. Instead of purchasing an insurance policy, they set aside funds or have sufficient financial reserves to cover potential future claims or damages directly. This approach is often adopted when the cost of traditional insurance is prohibitive, or when an entity believes it can manage its risks and potential losses more cost-effectively on its own.

Here are some examples to illustrate self-insurance:

• Example 1: A Large Corporation's Employee Health Benefits

  A large multinational corporation decides not to purchase a traditional health insurance policy from an insurer for its 50,000 employees. Instead, it establishes a dedicated fund and directly pays for its employees' medical claims, hospitalizations, and prescription drugs as they arise. The company manages the claims process internally or contracts with a third-party administrator, but ultimately, the financial responsibility for these healthcare costs rests with the corporation itself.

  This illustrates self-insurance because the corporation is directly assuming the financial risk of its employees' healthcare costs, rather than paying premiums to an insurance company to cover those risks. It is using its own funds to pay claims.

• Example 2: A Municipal Government's Vehicle Fleet

  A municipal government operates a large fleet of police cars, fire trucks, and public works vehicles. Rather than buying comprehensive collision and liability insurance policies for each vehicle from a commercial insurer, the city council allocates a specific portion of its annual budget to a "risk management fund." This fund is used to repair or replace damaged city vehicles and to pay out any liability claims resulting from accidents involving city property or employees.

  Here, the municipal government is self-insuring its vehicle fleet. It is not transferring the risk of damage or liability to an external insurer but is instead using its own financial resources (the risk management fund) to cover potential losses.

• Example 3: A Small Business Covering Minor Property Damage

  A small, well-established manufacturing company owns its factory building and machinery. After evaluating the high premiums for comprehensive property insurance, the owner decides to self-insure for minor property damage events, such as small equipment breakdowns or minor structural repairs. The company maintains a substantial cash reserve specifically designated for these types of unexpected repairs, while still purchasing catastrophic insurance for major disasters like fires or floods.

  This demonstrates self-insurance for a specific type of risk. The company is choosing to bear the financial burden of smaller, more predictable property damages itself by maintaining a dedicated reserve, rather than paying an insurer to cover these particular losses. They are directly managing and funding these risks.