Should You Self-Insure Your Business?
If you're like most business owners, insurance is part of your cost of doing business. Like any other business expense, though, insurance costs must be managed and controlled. When it comes to handling your business's risk exposure, you basically have three choices: (1) transfer the risk to someone else (this is really what buying insurance does for you), (2) retain all of the risk within the business (self-insure), or (3) create some combination of these two strategies.
What is self-insurance?
In essence, self-insurance means that your business is shouldering its own risk in one or more areas. Your business will pay claims out of pocket in those areas you've chosen to self-insure because you have not transferred the risk to an insurance company.
What are some reasons to self-insure?
The decision to self-insure is both a philosophical one and a financial one. Every business situation is unique, but there are some common issues for any employer to consider regarding self-insurance:
Cost issues and control: When you self-insure, you pay only for the cost of your claims, not for insurance premiums. These premiums include administrative costs as well as profit margins for the insurer. Although you'll still face administrative costs if you self-insure, you can eliminate the expense that pays for the insurer's profits. Depending on the type of benefits you provide (e.g., medical or dental care), self-insurance also allows you to set your own deductibles, co-payments, and maximum benefits. Finally, you can monitor your business's costs more easily.
Cash management: With traditional insurance, you pay roughly the same premium every month, regardless of the number or size of claims. If you self-insure, and your claims end up being low, you can keep more of your operating capital at work for your business. For instance, your business (instead of an insurance company) can be earning interest on unspent funds that you've earmarked for loss claims.
Benefit flexibility: As your own insurer, you have complete control over which benefits you want to offer your employees. This means that you can design and customize your employee benefit package to be very attractive to your current and future employees. In the area of health care, for example, you can give your employees the choice to see any doctor or specialist they want. You can also choose which risks to keep and which to transfer by combining a program of self-insurance with traditional insurance. Your business could self-insure for dental and vision benefits, for instance, but purchase medical coverage from an insurance carrier.
Company size: In general, larger companies with hundreds of employees get more benefit from self-insurance than small employers. These larger companies are able to spread their risk over a larger pool of employees. But depending on the area of coverage, even small businesses can benefit from self-insurance.
What are some drawbacks of self-insurance?
Administrative costs: With any type of insurance or benefit plan, someone must handle the claims and make payments. That often means additional staff and more payroll expense for your business. Another alternative is to hire an outside firm, known as a third-party administrator (TPA), to administer the program for you. A TPA will typically cost you 4 to 7 percent of your total insurance program costs.
Employee privacy concerns: If you do not hire a TPA, your staff will be processing claims for their coworkers. This can create tensions regarding the confidentiality of medical issues. Also, this puts you in the position of potentially having to deny coverage for an employee, rather than having the insurance company make that decision.
Cash-flow fluctuations: With a self-insurance program, your business's claim expenses may be low one month and much higher the next. These wide variations can certainly make business planning a challenge. Even if you choose to self-insure, it makes good sense to pay your self-insurance bill (just like paying an insurance premium) by regularly setting aside funds to handle claim expenses as they come up. Cash-flow problems can also affect your employees. For instance, your plan may require an employee to pay a doctor for treatment and then get reimbursed from your fund. If a doctor bill is substantial, the employee may not have the funds immediately available to pay the bill in full.
Note: You can purchase separate insurance coverage, usually called stop-loss insurance, to handle large or catastrophic losses. This is one way to combine self-insurance with outside insurance. There are two lines of stop-loss insurance. Specific coverage deals with claims for one employee, while aggregate coverage handles all of your employees as a group. For example, you might self-insure medical expenses up to $10,000 per employee and use specific stop-loss insurance to pay claims over and above that limit by any one employee.
Government regulation: Depending on your state's requirements and the type of self-insured plan you have, you may face some government regulation. Your state may require you to post a bond or set aside a certain amount of funds in escrow for potential claims. Even if you avoid restrictions like these, you may still have to provide some type of reporting about your plan to your state government.
What areas of risk can you self-insure?
Some employers, both public and private, use self-insurance for workers' compensation. But almost any type of risk can be self-insured. For example, you may want to self-insure chiropractic benefits because your employees do lots of heavy lifting. You can also offer dental benefits, vision benefits, life insurance benefits, medical benefits, or even long-term care benefits.
You make the decision based on what you want for your employees and the potential costs and benefits of your choice. If self-insuring certain risks by offering benefits directly to your employees makes sense for your business, you should consider doing it. Just remember that you may want to guard against potential catastrophic claims by using a mix of self-insurance and stop-loss insurance.
What else should you consider about self-insurance?
You should certainly review your past claims experience over the last several years. If your claims have been low, self-insurance may make sense. You should also examine your employee demographics. For example, if your employees are mostly young and healthy, it might be cost effective to self-insure their health-care expenses.
To the best of your ability, project what may happen to your business in the future. How stable are your revenues? What is your employee turnover rate? What will happen to your plan costs if you add a significant number of employees in the future? How might future changes in the organization itself, such as the loss of a key employee, affect your self-insurance plans?
Realize that if you decide to self-insure all or some of the risks faced by your business, it's in your best interest to reduce those risks wherever possible, because that will help lower your business's out-of-pocket costs. So, you may want to offer safety classes, emphasize preventive health care, and pay for employees to attend nutrition or nonsmoking classes. Spending a few dollars now on preventive measures like these may save your business big dollars in future claims.
For many businesses, a combination of traditional and self-insurance will make sense in terms of economics, employee satisfaction, and risk management. With prudent planning, the decision to self-insure can save your business money on insurance expenses. And that can mean a healthier bottom line for your business over the long run.
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