Is Self-Insurance Right for Your Organization?
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A self-insurance program is a retention plan in which a business keeps records of its losses and maintains a formal system to pay for them. Self-insurance can be a good fit for organizations that have a tolerance for retaining risk and a willingness to devote capital and resources to financing and administering a self-insurance program. Frequently, a self-insurance plan is combined with a plan that transfers risk to an insurance carrier above a certain threshold (retention). Many states require a self-insured organization to purchase excess insurance.
Administration of a self-insurance program requires extensive resources devoted towards claim adjustment, loss reserving, recordkeeping and litigation management. Commonly, organizations on a self-insurance program will enlist the services of a Third Party Administrator (TPA) to assist in this administration. Beyond claims administration, self-insurance also requires that an organization meet qualifications of the state(s) in which it seeks to self-insure loss exposures and make regulatory filings to such state(s).
Advantages to Self-InsuranceCompared with a traditional insurance program, self-insurance programs provide several advantages to an organization, including:
- Control over claims an organization can exercise direct control over the adjustment of its claims
- Risk control when an organization directly pays the cost of its own losses, it has an incentive to prevent and reduce them through risk control
- Long-term cost savings long-term costs tend to be lower than the cost to transfer risk to an insurance carrier
- Cash-flow benefits cash-flow is generated by retaining losses that are paid over a period of time, rather than paying the upfront cost of insurance
Disadvantages of Self-InsuranceWhile there are clear advantages to choosing a self-insurance program, an organization may choose not to self-insure for some of the following reasons:
- Uncertainty of retained loss outcomes the uncertainty of losses retained can negatively affect an organizations earnings, net worth and cash flow
- Administrative requirements the administration burden of claims management and regulated requirements is extensive
- Deferral of tax deductions an organization maximizes the present value of its cash flows by taking a tax deduction on risk retention and transfer expenses as soon as possible, rather than as paid over time
- Contractual requirements contracts with clients or other parties may require insurance on their behalf that a self-insurance program may not appropriately provide
ScenarioA common self-insurance scenario for a temporary staffing agency would be in regard to workers compensation. A temporary staffing agency may be self-insured in a state up to a retention of $750,000 (for example).The staffing agency will purchase an excess policy with an insurance carrier reflecting that the insurance carrier will begin to pay towards a loss once it hits the retention level of $750,000.Because the insurance carrier has only agreed to begin paying at a high claim dollar value, the premium cost for this excess policy is much lower than the cost to have the carrier cover all claims from the first dollar.
If the staffing agency has four claims in the amount of $250,000 each, it will be responsible for paying those claims itself, as each claim is under the retention of $750,000. If the staffing agency was to have one claim in the amount of $1,000,000, it will be responsible for paying the claim up until the point where the claim hits a value of $750,000, at which time the carrier will begin to pay.
Malecki, Donald S., Arthur L. Flitner, and Jerome Trupin. Commercial Liability Risk Management and Insurance. Malvern: American Institute for Chartered Property Casualty Underwriters/Insurance Institute of America, 2005.
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