Choosing Between Insurance and Self-Insurance

Choosing between insurance and self-insurance can be a confusing task, particularly for people whose exposure to such issues is limited. This paper is intended to help those who are faced with making these decisions to better understand the issues involved without being unduly technical. Armed with the basics, you will be in a better position to evaluate the alternatives and reach an informed conclusion.

INSURANCE

Starting with what is familiar, insurance is a mechanism for transferring the risk of financial loss to a professional risk bearer (the insurance company) in exchange for a charge known as a premium. Once the premium is paid, the insured bears no further responsibility for cost (other than claims within a deductible). The carrier assumes responsibility for managing the claims and paying for those which are deemed compensable.

Traditional insurance typically includes several types of services as part of the total package. These include claims management services, administrative services, and loss control services aimed at helping the insured minimize its exposures to future losses. Insurance is purchased by clients of all sizes and is an appropriate method to use when budget stability is important and the ability to prevent or control losses is limited.

 

SELF-INSURANCE

Self-insurance, by contrast, is an alternative to traditional insurance as a method for financing accidental risks of loss. There are several forms – so called retention plans, retrospective rating plans, and dividend programs being but a few of the more common examples.

In whatever form, the common thread is that the participant assumes an element of financial risk in exchange for a potential financial reward. If losses are well-controlled and minimized, the reward will be lower cost than insurance. If losses are not controlled, the risk is higher cost than comparable insurance.

In terms of services, it’s important to understand what types of claim, administrative and risk control services are included in any self-insurance proposal. Unlike insurance, there is often a wide variation on the services included with self-insurance. Buyers faced with evaluating self-insurance alternatives need to have a good understanding of what is included and what is not included and for what price.

When properly applied, self-insurance techniques may offer opportunities for effective cost savings in the long run. By its nature, self-insurance tends to make sense for larger accounts that can accept some level of budget volatility from period- to-period.

Clearly, self-insurance makes sense only if the buyer is committed to controlling losses in the long run, and has the desire and the resources to properly administer the program. Viewed from this perspective, self-insurance is not for everyone.

POINTS TO CONSIDER

The following sections contain a summary of things to consider when comparing insurance and self-insurance alternatives. It is organized in two parts:

• Qualitative Considerations. We begin with these "soft" items because they tend to be the most important – and also the most frequently overlooked.
  
  
• Quantitative Considerations. This section deals with the cost issues, which are not always as straightforward as they appear.

If the answer is "yes" to most of the checklist questions that follow, and if you are comfortable with the economics, self-insurance options may make sense.

If on the other hand the answers are "no" or "not sure" you should be seeking a partnership with professionals who have the resources and the know-how to deliver the total program on your behalf. MIIA understands your risks and how to manage them. Having been formed by the Massachusetts Municipal Association, MIIA is a non-profit service organization whose only business is municipal insurance.

We appreciate your support and very much want to continue our business relationship.

Qualitative Considerations

1. OVERALL ADMINISTRATION

	YES	NO
Does the town want to be involved in the details of running an insurance program (self-insurance)? Has the town analyzed the cost of errors and omissions in paying claims?
Will the town’s budget process accommodate significant variance from estimated costs, particularly upside swings in a "bad loss" year?
Is there an internal accounting system that will charge back self-insured claims to departments in which they occur? (Incentive to control losses where they occur)
Is there an adequate procedure in place to pursue insurance recovery from excess insurance carriers on individual or aggregate claims that exceed self-insured retentions?
Is there a complete understanding of all the cost elements to facilitate accurate comparison between insurance and self-insurance?

 

2. CLAIMS MANAGEMENT AND ADMINISTRATION

	YES	NO
Does the claim service provider have a pro-active approach to managing claim costs through such initiatives as: 1-800# claim reporting Early intervention/case management by occupational health nurse Investigation of serious accidents Return-to-Work program?
Does the claim service provider perform medical bill review? Utilization review?
Are medical and vocational rehabilitation services provided?
Does the claim manager file the first report of injury to the Department of Industrial Accidents?
Does the provider issue the claim checks and maintain the loss fund accounts?
Are detailed loss reports provided on a frequency to meet your needs?
Does the claim provider perform claims reviews for public safety employees?

 

3. RISK CONTROL/EDUCATION PROGRAMS

	YES	NO
Are workplace safety inspections performed? How often?
Are there training programs included for employee safety?
Are DOT drug and alcohol testing services made available?
Does the provider offer specialized publications, films, videos?
Are training seminars and workshops conducted?

 

4. COVERAGES

	YES	NO
While coverage is a separate issue from the financing vehicle (i.e. insurance or self-insurance), it’s important to carefully review and compare the coverages offered from competing sources. Are coverages, limits of liability and deductibles truly the same?

 

Quantitative Considerations

• When comparing costs, be sure the analysis is done on an apples-to-apples basis, reflecting all cost elements. This is not always self-evident, particularly where there are "unbundled" service components in self-insurance subject to separate charges. For example, does the claim handling charge include the cost of rehabilitation services? Training? Filing injury reports with the DIA?
  
  
• When evaluating claims costs, always use "developed" figures rather than simply "paid." Paid losses don’t tell the full story unless the claims are completely closed. Work with developed figures which reflect ultimate costs – i.e. what has already been paid plus an estimate for what will be paid in the future (reserves) to settle the claim.
  
  Please see the attached for a projection of developed losses for your town, based on industry-average development. If you are not comfortable with industry-average projections, use some other estimate, but do not ignore loss development!
  
  
• Always look at ultimate cost rather than just what is paid. Self-insurance often looks attractive compared to insurance because the cash outlay is less. While cash outlay will almost always be less under self-insurance at the beginning, this effect is temporary. Within only a few years, cash flow under self-insurance will increase. The following graphs illustrate:

In summary: don’t be lulled that favorable cash flow in the beginning translates to lower ultimate cost. Consider all elements over the life of the program. Ultimately, cost will be driven by how well losses are avoided and controlled.

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