Self-insurance: what it is and how it works

Self-insurance means that an organization pays some or all of its own losses from its own resources instead of transferring them to an insurer for a premium. The organization keeps the risk, funds claims as they fall due and arranges for them to be handled, usually while buying excess or stop-loss insurance above a set level. Being self-insured is a risk-financing decision, not the absence of one.

How self-insurance works

Self-insurance ranges from informal to formal:

• a deductible or self-insured retention under an insurance policy, where the organization pays losses up to an agreed amount
• a funded reserve or trust set aside for expected claims
• a regulated program, such as self-insured workers' compensation, which needs approval from the state
• a self-funded employee health plan, where the employer pays employees' medical claims

In each case the organization has to fund claims, administer them, often through a third-party administrator, and decide how much catastrophic exposure to transfer through excess or stop-loss cover.

What it requires

Self-insurance needs enough financial strength to absorb a bad year, reliable loss data to set funding, and a way to administer claims. Regulated programs add conditions. For workers' compensation, each state decides who may self-insure and on what terms; California, for example, issues a certificate to self-insure and requires private self-insured employers to post a security deposit. Self-funded health plans sponsored by private-sector employers are generally governed by federal law, chiefly ERISA, rather than state health insurance law, while the stop-loss coverage those employers buy is insurance that states can regulate.

Self-insurance, captives and self-funded health plans

• Self-insurance keeps the risk on the organization's own balance sheet, without an insurance company.
• A captive is a licensed insurer the organization owns. It formalizes retention in a separate regulated company and can buy reinsurance.
• A self-funded health plan is self-insurance of employee health benefits, with its own federal rules and usually a TPA and stop-loss cover.

Weighing it up

Self-insurance can lower the cost of predictable losses and give direct control over claims, but it brings volatility, administrative work and, for regulated programs, approval and security obligations. Whether it suits an organization depends on its loss profile, finances and appetite for risk, which is a question for an actuary, broker or consultant with relevant experience.

To compare self-insurance options and providers, see self-insurance solutions. For the wider picture, read the risk financing overview or what is a captive insurance company.

Educational information only; not insurance, legal, tax, actuarial or regulatory advice.