Risk Management Technique: Advantages And Disadvantages Of Self-Insurance.

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Individuals and businesses are familiar with the fact that risk and uncertainty are part of life.

Techniques have been developed to manage risks associated with human existence.

Risk management is the identification, assessment and economic control of risks that have the capacity to adversely affect assets and earning capacity of individuals and businesses.

One of the risk management techniques is self-insurance.

Self-insurance is an alternative to purchasing insurance to insure the first layer of a claim. It is an arrangement where an individual or a business set aside funds to meet insurable losses.

It must be noted that self-insurance is a conscious risk decisin in which a business or individual sets aside a pool of money to be used to remedy unexpected losses.

This is different from non-insurance where no fund is consciously set aside.

Does self-insurance have advantages? Yes it does, some of the advantages are;

  1. Self-insurance could be the source of constant reminder to control and reduce the risk of loss. That is, it could be used as an incentive to encourage and reward strict adherence to precautionary measures within a defined financial year.

2. If the funds set aside to self-insure were invested, the self-insured would claim the accrued profits.

A proportion of the profits could be used to increase the amount set aside for insurable losses and another invested in a new business.

3. A business that chooses the risk management technique of self-insurance pays lower premiums. This is because broker’s commission and insurers’ administration costs are eliminated.

Self-Insurance has disadvantages too. They are;

  1. A big loss that may wipe off the set aside fund could occur. The consequence may lead to the reduction or elimination of assets and earning capacity.

2. A business that chooses the Self-Insurance route may not have reach or spread of investments that an insurance company has.

Therefore, the fund set aside to meet insurable losses may be tied up in low yield short term investments.

At the end, taking the Self-Insurance option may not be a good investment decision.

3. Another disadvantage is the non-availability of technical advice on risk prevention.
Insurers’ manage risks for many individuals in diverse professions and businesses providing different services.

These relationships are a great source of useful knowledge which clients could benefit from.

4. Premium payments are allowable charge against corporation tax (for businesses) and income tax (for individual with life insurance – through tax rebate).

Contributions to funds set aside for self-insurance do not qualify as a charge against tax.

There may arise pressure on management to make ex gratia payments, that is payments outside the cover. Such payments will deplete the fund.

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