For this month’s blog post, I thought I would discuss one of the questions that I have been hearing from clients and prospective clients recently. The question that I have been hearing is “Can’t I just self-insure?”.
For context for this question, this is boiling down to a conversation regarding life insurance, disability insurance, and long-term-care insurance.
First, I think it would be helpful to explain what “self-insuring” means. Self-insuring is the process of setting aside assets to have a bucket of assets for specific purposes. A couple of circumstances people often talk about self-insuring for are events like premature death, a disability that prevents you from working, or long-term-care expenses later in life.
When you set aside assets to “self-insure” they need to be conservative, due to the uncertainty of when the assets would have to be used. For example, let’s consider incurring a disability, whether it be a sickness or injury that prevents you from working. What is the date that the disability occurs? We are never going to be able to answer that question because we just don’t know. The same concept applies to both life insurance and long-term-care discussions. So, to self-insure you would need the assets you are bucketing for these events to be in something like cash, or treasury bonds. Assets that have been historically extremely liquid and conservative.
So now let’s step back and look at the role of insurance. The role of insurance is extremely simple. The purpose of insurance is to transfer risk to the insurance company and away from a personal balance sheet. The question is, does it make sense to self-insure or transfer the risk from a financial perspective? Let’s look at the future value calculation below:
The future value calculation on the left, assumes you are saving $20k per year to self-insure yourself from a life, disability, or long-term care event. We are assuming that we can get 3% annualized growth since we established this would have to be conservative investments. On the right, we are assuming that we only invest $15k per year but can get a hypothetical return of 6% per year. We are also assuming we are taking the remaining $5k and using insurance to transfer the risk.
When you look at the future values of this hypothetical example, the future value on the right is better. Look, everyone hates to pay insurance premiums, but at the end of the day is it an expense if you can structure your financial plan like this? You be the judge, please reach out to me with any questions.
Hypothetical examples are not intended to suggest a particular course of action or represent the performance of any particular financial product or security.