Non-Insurance and Self-Insurance

Insurance is a risk transfer mechanism, where you pay a token (called premium) to a third party (insurance company) to assume your risks. After this consideration (payment of the premium), an agreement is drawn (policy document). If during the period of the agreement, the risk the policy holder transferred to the insurance company occurs, the insurance company pays him compensation (claim) subject to the limit of the policy. A major essence of non-life insurance is indemnity, which is restoring the policy holder to his pre-loss financial position and that is what the agreement seeks to do, all things being equal. As we explained previously, life policies are not policies of indemnity since you cannot place value on life or limb. Here the sum assured chosen by the policy holder, among other factors, is the determining factor in payment of compensation.

However, some people or corporate organisations opt for self-insurance. Self-insurance occurs when an individual or a corporate body insures himself/itself or its interest by maintaining a fund to cover possible losses rather than purchasing an insurance policy. In other words, the person retains the risks and keeps money aside to meet up any expenses should the event occur. For instance, a person bought a N10m car. Instead of doing comprehensive motor insurance to cover loss by fire, theft and own accidental damage, he does only motor (third party) insurance to cover his third party liabilities. And the only reason he is doing the third party insurance is because it is compulsory and it is an offense to put a motor vehicle on a public road without the third party insurance. Self-insurance, in this case, means he has kept N10m aside to replace the car in event of loss or enough money to fix it in the event of accidental collision. Remember, his compulsory third party insurance will cover repairs for third party vehicles to the tune of N1m (some motor policies offer N2m) if he is at fault.

The same thing applies to buildings and other assets. If you built a house and self-insure it instead of taking a fire and special perils policy to take care of loss or damage, it means you have kept a reasonable sum of money aside to rebuild, repair or reinstate in the event of damage. If you did not insure your assets and you did not keep some money aside to repair, replace or reinstate, your case is that of non-insurance, aka penny wise, pound foolish.

Usually entities which do self-insurance are large organisations with financial muscles. They keep large sums of money aside to take care of the health matters of employees and replace stolen and damaged assets, etc., but some organisations get bogged down and distracted by self-insurance. That is why many big organisations simply transfer their risks to insurance companies via insurance brokers who act as their agents. Some very rich individuals also do self-insurance. A man may have a garage (cars) worth N200m. he feels that if one car is damaged or stolen, he has others to use immediately until he repairs or replaces the car. He simply does third party insurance for all the vehicles. You may wonder why somebody will decide to spend N30m to replace a vehicle when he could just have paid a fraction of N30m in annual premium and transferred the wahala of the replacement to an insurance company. It is his money and he decides how he wants to deploy it.

But the reason for today’s article is to draw attention to the difference between self-insurance and non-insurance. Self-insurance is when you deliberately decide to self-insure and keep money aside to take care of the risks you ought to transfer to an insurance company if they occur. Non-insurance is when you deliberately refuse to insure your risks and assets, meanwhile you have no financial provisions to take care of loss, damage or other eventualities should they occur. You have only one car valued at N2m; have you set aside N2m to replace if it is stolen? Do you even have N2m to replace it? Even if you have, don’t you have more pressing things to do with the money? Why can’t you spend about N100,000 annually to secure your car via insurance, of course, through a registered insurance broker, who will help you sort out all the details at the point of taking the policy and during the period of the policy. He will also handle your claim should an incident leading to a claim arise.

Again, that house you built 20 years ago while you were still working, can you rebuild today if it is damaged by fire? If yes, you are self-insured, albeit, not deliberately. If no, you have no insurance at all and you need to take action. Depending on the value, you might just be surprised to find out that the premium is as low as N30,000 per annum. When insuring your building, always remember that it is the structures and fittings (contents also, if you add them with payment of additional premium) only you are insuring. I have had clients who quoted N100m as the value of the building. By the time I did physical inspection, I found out that the building cannot be more than half of the value they quoted. What happened is that they added the cost of the land. When insuring buildings, you do not add the cost of the land. You cannot lose your land to fire.

Let us just dwell a little bit on partial insurance. Some people deliberately underinsure their assets. Some do it thinking that they can outsmart insurance companies in the event of a claim for partial loss. Some do it consciously to partly transfer some of the risk of an insurance company; for instance, a man buys a car for N10m but insures it for N7m. He feels that if the vehicle is stolen and the insurer pays N7m, he has N3m to make up the money to get a replacement. Whether you underinsure deliberately or accidentally, just have it in mind that insurance has mechanisms for ensuring that you do not get more than indemnity. One of them, which applies in this case, is called average. Average is a mechanism for taming policy holders who underinsure. For instance, if your car is worth N2m and you insure it for N1.5m, if there is a claim of N200,000, the insurance company will only pay N150,000, leaving you to bear N50,000 or 25 per cent of the claim representing your 25 per cent underinsurance.

Finally, the insurance industry has an institutionalised underinsurance or partial insurance called First Loss Insurance, which we shall treat subsequently.