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Wednesday 19 August 2020

The Self-Insurance Snowball

Just when you thought Winter was
 nearly over. 
Insurance is good business - it’s why the actuaries get paid so well! When Maths is on your side, you know you gonna win.

The average insurance premiums are designed so that, on average, for the average person, the insurance company wins. (Wow that’s a lot of averages in one sentence – see I told you Maths was against you).

The way insurance works is that the premiums of the many subsidize the losses of the few, plus some decent profit for the insurance company. So when it comes to insurance, chances are you are going to lose.

And for those that do start winning? Well, their premiums are adjusted upward accordingly.

So it makes sense that over the long term, the average person will be better off with as few insurance products as possible. Yes?

But please, don’t run off and cancel all your policies!

The problem is that insurance is pretty also really important – the risk of some events derailing your entire life are very real and need to be insured.

So wouldn’t it be awesome if you could have the benefit of insurance without needing to pay an insurance company? Luckily there is a way to do this – it’s called self-insurance.

What Is Self-Insurance?

Self-insurance is when you have money set aside to cover you for an event you would normally take out insurance for. If the event you are self-insuring for happens, then you cover the cost from your own pocket instead of claiming from an insurance company.

A lot you may already be self-insuring without even realising it. As an example, your excess on your car insurance is actually a form of self-insurance since you will need to cover the excess in the event of a claim.

And of course an emergency fund also serves as a sort of all-purpose self-insurance tool that, depending on the size, could cover anything from a new car battery to your salary for a few months if you lose your job.

Self-insurance means you weighing up the certainty of spending money on insurance premiums versus the possibility of incurring a loss that you will pay for yourself. The benefit is that money which was previously going to an insurance company in the form of premiums stays with you, and over the long run, on average you will score. The more things you are able to self-insure, the better off you’ll likely be.

So how do you go about self-insuring?

Well, let me introduce you to what I like to call the Self-Insurance Snowball Method (patent pending).

The Self-Insurance Snowball Method

The snowball method for self-insurance is pretty similar to the snowball method for debt elimination. In the debt snowball method, you pick your smallest debt and then use an additional payment to squash that. After that, you take that debt’s installment value and roll it into the next biggest debt until that one is eliminated. Then you take the previous two debt installments and roll it into the next biggest debt and so on and so on, creating a snowball effect that gets bigger and bigger until you are debt free.

The snowball method for self-insurance works in the same way. First you pick your lowest value insured item/event (this will likely be the lowest of all your premiums). Put away a monthly savings amount until the item/event is self-insured. Then roll that insurance premium into the savings pool until you have enough to self-insure your next highest valued item/event. Then roll that premium into your savings pool etc. etc.

It's pretty simple in theory, but understand that it is not going to happen overnight, and it will require some patience and discipline. It is also important to know that this method assumes that you have an emergency fund set up – if you don’t, you should probably do that first.

Okay, so here is an example of how the self-insurance snowball might play out in practice.

Maybe your lowest valued insured item is your Cellphone. Let’s say it is worth R3,000, and the premium is R150 a month.

Now assume the worst. Your phone gets stolen or you drop it in the toilet, and you find yourself in the...er…shit.

Well, to be honest, if your emergency fund is up and running, this is actually no problem and you could just foot the bill of a new phone out of your emergency fund. Alternatively you might have a spare phone lying around that you wouldn’t mind using.

But if these two options don't work, then you would need to carry on building your savings until it is at a value that could handle replacing your phone.

Either way, your cellphone is now self-insured. You can go ahead and cancel your Cellphone insurance. And voila, you have the first part of your self-insurance snowball ready to…er…roll!

So next up, make sure you start saving the R150 premium you were previously paying for your Cellphone insurance (it is probably best to do this immediately and automatically - to make sure that the R150 goes to where it is supposed to).

Now find your new lowest value insured item – maybe it is funeral cover, or a laptop. Let’s say the insured value is for R8000 with a premium of R250/month. Wait until the R150/month saving from your previous Cellphone insurance boosts your savings to a point where you are comfortable that it could cover you. You are then ready to self-insure, and you can now use the R150/month + your new R250/month you have freed up to snowball towards saving for self-insuring the next item.

(I must maybe just mention that for something like funeral cover, you should probably put the self-insurance savings into an account that can be accessed by your family if they need it.)

You can keep snowballing like this and knock off insurance premiums one by one. Maybe the next item is your car. Now this one can be a biggie, and it could take a very long time. A slightly different approach could be to self-insure a higher and higher excess over time. For example maybe aim to save up an amount that would cover a R5,000 excess. Then call up the insurance company and tell them you want to increase your excess. This will lower your premium. Then roll those savings into your snowball and aim for a R10k excess. Rinse and repeat until the car is self-insured.

And that’s the basic idea – roll any self-insurance savings into self-insuring the next item/event. Just keep rollin, rollin, rollin...

How To Self Insure

1) Make sure you have an emergency fund. If you don't, build one up.
2) Find your lowest value insured item/event. Self-insure it by either:
  • Checking if your emergency fund/savings can cover it
  • Building up enough savings to cover it
  • Using an alternative way (e.g. if you have a spare, getting by without, other out the box ideas)
3) Start saving the self-insured item/event’s insurance premium.
4) Revisit step 2 until there are no more items/events you can self-insure.

There are maybe just two more things I want to mention…

The first is that the above scenario assumes smooth sailing with no claims. If along the way you need to make a “self-insurance claim” it may knock your savings, and you may need to re-instate some insurance at a company to cover you until your savings have been built up again.

The second important thing to know is that, unless you are exceptionally wealthy, it’s probably not a good idea to self-insure everything. Some things are best left to insurance companies.

What Not To Self-Insure

Insurance is designed to cover you for events that you would not be able to cover on your own. Now when the cost of the event is known, it is pretty easy to figure out if you are in a position to make it right on your own.

That means that if the amount needed to self-insure is more than what you could save (even in a lifetime), or if the amount needed to self-insure is unknown, then it is probably best to pay the premiums and not try to be be too clever.

For that reason, I am definitely going to be keeping these insurances:
  • House insurance – Even if I start now and save until the day I die, I will probably never be able to build up enough cash to replace a house.
  • 3rd Party Car insurance – Self-insuring a car is possible because you know the replacement value. But I definitely would not be trying to self-insure for 3rd party claims. Imagine back ending a Ferrari and being deemed responsible?
  • Hospital cover – I already self-insure my medical day to day expenses, but I have no plans of trying to self-insure my hospital cover. A hospital visit is one of those bills that really has no upper limit. Imagine being admitted after back-ending the Ferrari from above and spending 3 months in ICU after multiple organ transplants and 42 MRI scans.

The Ultimate Self-Insurance

Now just before we are all insuranc-ed out, I just want to quickly discuss one last type of insurance – life insurance.

Life insurance is there to cover the bills when you are gone. To me that makes self-insuring your life the ultimate self-insurance achievement. If you have enough funds built up that you are able to cover your bills even if you are not there to earn a salary, it means you have achieved financial freedom.

Personally, this is one insurance I am really looking forward to cancelling!

Till next time, Stay Stealthy!
 - ~ - ~

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