The Disadvantages of Self-Insurance

Once a decision to Self-Insure has been established the principal disadvantages are the exposure to risk and the possibility that the program will end up costing more than the program would have done were it insured in the traditional markets. It is important to note that self-insurance should be viewed as a long-term strategy as some of the advantages may take time to pay dividends. For example a workplace loss and safety training program may take some time to become fully implemented.

Potential disadvantages of Self-Insurance can be summarised as follows:

Exposure to Poor Loss Experience

A self-insurer can suffer from poor claims experience in any one period however any potential downside can be limited by specific and aggregate reinsurance. If the program continues to show poor results then the cost of the spec and agg will increase and self-insurance may ultimately become uneconomic.

The need to establish Administrative Procedures

Self-Insurance requires the setting up of systems to settle and monitor claims as well as negotiating with other service providers such as excess insurers. However this function is often out-sourced to a professional administrator known as a Third Party Administrator (TPA).

Tax

As with most business expenses, all expenses relating to Self-Insurance are tax deductible. Self-insurers need to be aware that with regard to losses a tax deduction can only be taken when losses are paid rather than incurred. This issue can affect a companies cash flow in the short-term but the disadvantage is most applicable to companies that are self-insuring classes of business such as general liability that are known as long-tail due to the fact that they take several years top settle. Workers Compensation claims are paid out over many years but often the self-insurer is able to commute claims by purchasing an annuity policy on behalf of the claimant and achieve an immediate tax deduction.