Start Your Own Self-Insurance Company

I recently started my own self-insurance “company”. Here are some details about my new company.

  • Startup Costs: $0
  • Startup Time: 30 minutes
  • Business Purpose: Take on an increased, although still small, part of the risk of driving a car, owning a home, and purchasing appliances and electronic equipment.  
  • Revenue: Modest but steady. Right now my revenue is $50 per month but this will increase as I take on more risk.
  • Expenses: Unknown. Based on my family’s driving abilities, the laws of probability, and good old-fashioned luck.
  • Future Prospects: Unlike most businesses, which fail in their first few years, the odds are favorable that my self-insurance company will survive for the long term and make a modest profit most years.

Insurance and Regret

From a purely economic standpoint, insurance doesn’t make sense. Every time you purchase insurance you are entering into a gamble with an expected negative value. Insurance companies pay a lot of very smart people called actuaries a lot of money to ensure this is true. Insurance companies are not charities whose goal is to protect you from unexpected disasters but businesses designed to make money.  

And yet insurance companies have thrived for thousands, of years. This made no sense to economists whose entire profession is built on the theory that people are rationale and act in their own best interest. If people are rationale why do so many willingly enter into insurance contracts with negative expected values? This was the paradox facing economists.

The answer came not from an economist, but from Noble Prize winning psychologist Daniel Kahneman. Kahneman correctly identified the decision to purchase insurance not as a purely economic decision, but an emotional one as well, and the emotion pushing people to buy insurance was regret.

Not actual regret but “the anticipation of regret.” We imagine something bad happening in the future and further imagine our regret if we don’t act now to protect ourselves against this imagined future disaster. Regret is the reason insurance companies thrive.

Indeed, insurance premiums can be usefully thought of us regret premiums. We willingly pay the premium now, even though we know it doesn’t make sense from a purely economic standpoint, in order to avoid future regret.   

This human desire to avoid regret can be both beneficial and harmful. It is beneficial when we use it to insure against catastrophes but harmful when we use it to insure against inconveniences. You should gladly go on paying insurance premiums to protect yourself against the type of disaster that, in the words of Winston Churchill, would “smash [you] up forever” but if you are paying insurance companies to protect you from life’s small emergencies you should stop immediately and start paying this regret premium to yourself. This is where your own self-insurance company comes into play.

Starting Your Own Self-Insurance Company

So how do you start your own self-insurance company? It really is simple. Here is how I did it.

  • Establish an emergency fund – Before starting your self-insurance company make sure you have at least a small emergency fund. How much you have in this fund is up to you, but I suggest a minimum $1,000.
  • Set up an online savings account dedicated to self-insurance – I use Capital One 360 for my online savings accounts because you can set up multiple accounts quickly and easily. Your regret premiums will be paid into this account.
  • Raise the deductible on at least one insurance policy – I started by raising the deductible on my auto insurance from $500 to $1,000. If your deductible is $100 you might consider only raising it to $500 initially.
  • Set up an automatic transfer of the monthly savings to your self-insurance company. Calculate what you save each month by raising the deductible and transfer this amount to your self-insurance account. An automatic transfer at the same time you pay the insurance premium works best.

As time goes on and you build up some money in your self-insurance account consider raising your deductible further. With auto insurance, if you drive an older vehicle it might be wise to cancel your collision coverage altogether. Money magazine suggests ditching your collision coverage if your car is more than 10 years old or worth less than 10 times what you pay annually for collision coverage. Also consider raising the deductibles on other policies such as your homeowner’s policy.

Extended warranties are a huge money-maker for insurance companies and the ultimate example of paying a steep price to avoid the regret, not of a catastrophe, but of an inconvenience. If you are in the habit of buying extended warranties stop immediately and start paying what you would have paid into your self-insurance account.

Regret Scoreboard

Kahneman suggests establishing a broad based risk policy rather than approaching each insurance decision in isolation. Two rules he suggests for a rationale risk policy are:

  • “Always take the highest possible deductible when purchasing insurance.” and,
  • “Never buy extended warranties.”

I would add a word of caution that the “highest possible deductible” is not the best choice for everyone. Instead, choose the highest deductible that would not be catastrophic for you.

Kahneman than adds, “…you expect the occasional loss of the entire deductible, or the failure of an uninsured product. The relevant issue is your ability to reduce or eliminate the pain of the occasional loss by the thought that the policy that left you exposed to it will almost certainly be financially advantageous over the long run.”

Kahneman is brilliant, and I hate to disagree with him, but I think for most of us the act of simply thinking that our temporary loss has been offset by prior gains would do little to minimize our regret. If we suffer a loss due to increasing a deductible or not buying a warranty we are going to feel the regret even if intellectually we know we shouldn’t.

Your self-insurance company solves this problem by creating a regret scoreboard. If you have several thousand dollars in your self-insurance account, and have to pay $1,000 out for a deductible on an auto accident, you will certainly regret causing the accident and having to pay the money, but you will not regret raising your deductible.

The money in your account is there just for that purpose and is concrete evidence that the decision to self-insure against this type of risk was a wise one. Paying a regret premium to yourself allows you to keep score in an incredibly compelling way that goes a long way to solving the problem of regret when you self-insure. 

Float Your Boat

From the beginning Warren Buffett has loved investing in insurance companies and some experts see this as one of the keys to his incredible success. One of the things that intrigued Buffett about the insurance industry was the concept of float.

Float is the time difference between when premiums are received by insurance companies and when claims are paid out. During this time the premiums can be invested. Float from insurance companies allowed Buffett to have more money to invest than he otherwise would have had.  

This same concept can be put to use by you, albeit on a much smaller scale. The regret premiums you pay into your self-insurance company can be invested until they are needed to pay out claims. I recommend keeping a couple thousand dollars in a simple, safe, and liquid savings account but if the money in your account grows larger than this feel free to invest it more aggressively.

While the money you pay yourself for self-insurance won’t be enough to make you rich, even if you are lucky in avoiding claims and successful in investing it, having extra money to invest can only be seen as a good thing. So take a hint from the world’s most successful investor and use insurance float to add to your available investing pool.

In conclusion, starting your own self-insurance company is a great way to use the insights of behavioral economics to benefit your bottom line. The very human need to avoid regret can help you make the wise decision to insure against potential catastrophes but it can work against you when you insure against small emergencies and inconveniences. Avoid this temptation by starting your own self-insurance company and paying a regret premium to yourself. It will almost certainly be a wise financial decision while at the same time allowing you to avoid the future regret of taking on increased risk.

Additional Reading: The 10 Smartest Things Ever Said About Insurance      

17 comments for “Start Your Own Self-Insurance Company

  1. Matt @ Optimize Your Life
    April 25, 2017 at 8:13 am

    I love this approach. I think you are right that Kahneman’s approach makes sense intellectually but is harder to swallow emotionally. Your scoreboard goes a long way to helping the emotional side of it.

    I think a lot of us in the personal finance space recognize this with regards to whole life insurance. If we can take what we would have been paying in premiums and invest in into building our wealth, then we will end up with a larger amount to pass on than the insurance alone would allow. It is certainly more of an emotional issue to push the rationale into homeowners insurance or health insurance, though. With the life insurance we don’t have to feel the regret because we aren’t around when it is cashed out!

    • Brent Esplin
      April 25, 2017 at 9:05 am

      Thanks for the comment. I also really like the “scoreboard” aspect of this approach. It is one thing to know intellectually that this approach should work. It is much more powerful to see the money in your account and have evidence that it is working.

  2. alejandro
    May 2, 2017 at 8:41 am

    really good job. cheers from the dominican republic!

    • Brent Esplin
      May 2, 2017 at 9:11 am

      Thanks. Glad you found it helpful.

  3. May 2, 2017 at 12:47 pm

    Great explanation of the purpose and price of insurance.

    I try not to insure the things I can afford to replace. I never buy insurance on consumer products like phones or electronics. I’ve raised the deductible on our home insurance to $10,000.

    When I became financially independent, I dropped term life and disability insurance, saving myself over $300 a month. It’s great to be self-insured.

    Cheers!
    -PoF

    • Brent Esplin
      May 2, 2017 at 1:32 pm

      You definitely understand the concept and are implementing it at a very high level. I am starting out much smaller but will get there over time. Thanks for the comment.

  4. Phyllis Bratton
    May 3, 2017 at 12:49 pm

    My husband is a Type 1 diabetic, and life insurance was a nightmare to get. Aside from being chronically ill, he is very healthy (at age 70!) Long term care insurance is completely out of the question. So we converted some of our retirement savings to an annuity that is completely dedicated to his long term care, should he ever need it. This will not cover everything, but we now have about enough for one year in a nursing home, and it is heritable, unlike insurance, so it works for us.

    • Brent Esplin
      May 3, 2017 at 4:10 pm

      That is an interesting self-insurance strategy. Hopefully your husband won’t need the long-term care but it is nice to know the resources are available if needed. Thanks for the comment.

  5. Jules
    May 3, 2017 at 1:36 pm

    Well hang on – I think you’re missing a big part of insurance, which is the peace of mind factor. £90/year buys me up to £10M in travel health coverage almost anywhere in the world, plus several thousand in interruption and cancellation cover. In the ten years I’ve had the policy, they’ve paid out at least equal to my premiums in cover, and I’ve had the peace of mind that comes from knowing I can just place a phone call and go see a doctor if I think I need one.

    Likewise, my equestrian safety gear needs to be replaced every three years, and I budget for that, but it’s also insured in case it needs to be replaced sooner than that because it gets damaged or stolen. Could I afford to “self-insure”? Sure. I insure it so that my safety-minded self will replace it promptly rather than letting my frugal self compromise “for a while” to keep costs down.

    Self-insuring isn’t for everyone and you need to be sure you can (and will) afford to do what’s right when life goes wrong.

    • Brent Esplin
      May 3, 2017 at 4:07 pm

      I am not suggesting getting rid of all insurance, or even most insurance. I am only suggesting not insuring against things that would be simple inconveniences. Raising the deductible and actually saving the money you save in a dedicated self-insurance bank account would allow you to keep your peace of mind and most likely pay off financially as well. However, every situation is different, and if you are happy with your present insurance situation that is wonderful. You have definitely thought things through, which puts you ahead of most people. Thanks for contributing to the conversation.

  6. May 4, 2017 at 8:26 am

    Thoughtful write up of a topic that few people understand. An HSA is an example of using this principle for your healthcare needs. Instead of pay insurance premiums to someone else that they get to keep if you don’t use them, why not pay premiums to yourself? I wonder this about my car insurance all the time. I’ve been paying monthly for almost 30 years without ever using it. Just think of what I would have invested at this point!

    • Brent Esplin
      May 4, 2017 at 11:39 am

      Your right. And an HSA comes with the added benefit of tax advantages. But even without the tax advantages self-insuring against small emergencies is still a good move. 30 years without a claim on your car insurance is very impressive. I think it’s time to raise that deductible as high as you can. Thanks for the comment.

      • May 4, 2017 at 12:02 pm

        Trouble is hindsight is 20/20 and the future is still murky. My chances of an accident may be lower based on my history, but not too much lower. Plus now I have teen drivers!

        • Brent Esplin
          May 4, 2017 at 1:56 pm

          Teenaged drivers definitely change the probability equation, but the added risk is also priced into your policy. You will save more by raising the deductible now than you would have before having teenaged drivers. However, I definitely understand the apprehension with raising the deductible when you have teenagers. Perhaps some kind of plan to let them share in the risk of an increased deductible and the reward of the savings if they avoid causing accidents might be something to consider.

  7. May 4, 2017 at 2:05 pm

    Humm. Shared risk and profit sharing. Good concepts for teens to learn. Will consider it. 🙂

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