Life Insurance By Self-Insurance: Is It Right For You?

Self-insurance is having enough money set aside that your loved ones would be taken care of. If you have saved enough money that all your remaining financial obligations are fulfilled, you are self-insured. At this point, you do not NEED life insurance.

However, you may still WANT life insurance as part of a tax-efficient estate plan.

Is self-insuring instead of purchasing a life insurance policy right for you? When should you self-insure?

What Is Self-Insurance For Life Insurance?

Self-insurance is simply having enough assets that your loved ones won’t be able to outlive your funds. If you have accumulated enough wealth, you may opt to not purchase a life insurance policy. By forgoing a life policy, you can save money on premiums and have less of your money go to the insurance company as charges and fees.

Therefore, if your assets are enough to cover the financial needs of your family in the future, you are self-sufficient. You can likely self-insure at this point instead of purchasing life insurance.

Calculating your life insurance coverage need will take some planning & work on your part. It isn’t as simple as reaching some arbitrary number like $1 million. You need to figure out the expected expenses of your loved ones in the future that need covering. There are many methods to figure this out. Some are simple and others entail assumptions around changes in expenses due to changes in lifestyle, inflation, and how long they may live.

Is Self-Insurance Really Insurance?

It is important to note, that ‘self-insurance’ is not technically insurance.

Insurance implies some transfer of risk. When you buy an insurance product, you implicitly are passing risk onto the insurance company for a fee (the premiums you pay). If markets underperform or if you live too long/not long enough, the insurance company will share that cost.

Insurance companies operate under the law of large numbers to smooth out the risk of any one life. The law of large numbers states that as the sample size gets bigger, the results will trend towards expectations. So any 1 person may die today or live over 100, but if you have 10,000 people, you can expect the average to be around 85.

When you self-insure, you retain all the risk. And without risk transfer, it isn’t technically insurance. This doesn’t make it any less useful, but is worth noting the difference.

Advantages of Self-Insurance

There are certainly benefits of self-insuring:

• No Premium Payments – since you don’t have to pay premiums, that is more money you can save & invest to grow
• No Policy limits – you don’t have any restrictions that are common on insurance products.
• Flexibility – You get flexibility in both how you contribute to the fund and when you take money out of the fund
• Lower fees – Insurance products have high fees & charges, especially products with cash value. (Permanent insurance like universal life (UL) and whole life (WL) have cash value). You can invest your self-insurance fund in a low fee ETF for lower overall expenses.

Self-insurance is a simple and low-cost way to provide protection to your loved ones.

Disadvantages of Self-Insurance

Self-insurance does come with its own share of risks:

• Investment & Market Risk – Life insurance products let you share risks with the insurance company. When you self-insure, you take on all the investment & market risks yourself. If your self-insurance investments drop significantly, you could be leaving much less money to your beneficiary than you planned.
• Planning Challenges – To be successful as a self-insurer you need to have a plan and a separate account. You need to be disciplined to not use the funds for other purposes.
• Taxes – Life insurance benefits tend to be tax-free for your beneficiary. Self-insurance may not have a similar tax-advantage.
• Estate Planning – Another benefit of life insurance is efficient estate planning. If you self-insure your assets may go through probate court when you die. Life insurance will go right to your named beneficiary and avoid public probate.
• Nursing Homes – If you or your spouse need end of life care, it can be a big drain on your assets. Life insurance is typically excluded from consideration as a source of funds. This means you won’t drain all your estate if you need care.

Even if you are self-sufficient, you may decide to keep life insurance to protect from some of these risks. Most permanent life insurance can be fully paid in one lump sum. This allows you to guarantee money is left to your beneficiaries without worrying about an ongoing expense.

How To Use Term Insurance To Help You Become Self-Insured

It may seem counterintuitive, but buying term insurance can help you on your path to being self-insured. Unless you had huge financial success in your early 20s or benefitted from family money, you likely won’t have the assets to self-insure right away.

When you are young, your earnings are likely lower. And your expenses make up a large percent of your income. This is especially true if you are paying off student loans and/or buying your first house. If you have children that adds additional expenses.

Having a term life insurance policy can be a low-cost coverage option while you build up savings. Buying term life insurance and investing the difference (BTID) is a way to have coverage and still save. You will have financial protection over the period of time you need it before you are established enough to self-insure.

Self-insuring is simple, but can be hard to do with on a starting salary while paying loans, kids, and a mortgage.

How To Become Self-Insured

The key to becoming self-insured is to grow your assets to a point they can sufficiently cover your expenses. To do this, you likely need a budget that is maintainable for your lifestyle. By budgeting and keeping expenses low, you will have enough leftover to invest.

Being self-insured just requires enough savings to cover all the future expenses of your dependents. Building up a separate portfolio can be done by investing early, investing often, and diversifying your investments.

It is important to name a beneficiary on any retirement accounts. This helps keep the accounts out of court where a judge can direct where your money goes. Most account administrators allow you to name multiple beneficiaries so you should update your accounts at major life events.

Additionally, as part of estate planning, you should have a will and trusts set up to expedite the process. Trusts also allow for you to set rules around the disbursement of funds from the trust. You may want to limit how quickly a child can access the money or the purposes to use it for, for example.

As your wealth grows, your need for life insurance decreases. If you make a plan and stick to it, you will eventually have saved & invested enough to be self-sufficient. Although, there are still benefits to having life insurance as part of an estate plan.

The Final Word – Self-Insurance over Life Insurance

At its core, self-insurance is just having adequate wealth to provide for your dependents. Many retirees eventually get to the point of self-insurance. If your children are grown, your mortgage is paid off, and you have low expenses, your threshold to self-insure becomes much lower.

However, there may still be reasons a life insurance product make sense. Life insurance tends to be excluded as a source of funding for end of life care, is tax-efficient as a means to pass on wealth, shares risks with the insurance company, and helps with estate planning. Additionally, most permanent life insurance can be funded in a single contribution which removes uncertainty.

If you want to be self-sufficient at a young age, you will need to budget, save, and invest.

At the end of the day, all insurance decisions are unique to you. You should review your options and figure out if self-insurance fits into your personal financial plans.

Frequently Asked Questions (FAQs)