The question of self-insurance: Helping clients navigate the risks

Self-insurance has become a captivating concept in today’s world, driven by the complexities and challenges of modern insurance policies. Although it presents an alternative, it’s not without its risks and considerations. It’s important to understand the evolution of insurance, the current issues shaping its transformation and the implications for individuals considering self-insurance as their primary option.

A look back in time

The insurance industry traces back to Benjamin Franklin’s establishment of house insurance, which, in the beginning, covered only fire damage and the structure itself. Over time, this concept expanded, evolving to encompass the contents within homes. A competitive landscape emerged as various entities vied to outdo one another with more comprehensive policies. It took centuries for insurance to advance from its rudimentary beginnings to what it is today.

Forces shaping the current landscape

The landscape of modern insurance has shifted dramatically since Franklin’s days. As a result of where houses are constructed and the fact that many homes now include advanced technology - such as smart door locks, lighting systems and alarms - insurance policies are more complex than ever before. And, because homes are more advanced, the policies that are needed to cover them need to be more advanced.

The increase in both frequency and severity of intense storms and other weather-related events further complicates the insurance paradigm, resulting in more and more billion-dollar losses. No longer are California and Florida the only two problem states, as climate change is increasing bad weather everywhere, and insurers are struggling to keep up. Modern homes are now built to withstand different environmental factors, yet these changes have not been universal. This is leading to vulnerabilities from unexpected and unprecedented weather events.

The coverage conundrum

In the face of mounting risks and changing landscapes, insurers are challenged with collecting adequate premiums while adhering to state regulations. State insurance commissions, designed to regulate premium hikes and protect consumers from overpayment, are inadvertently constraining insurers from adjusting rates swiftly enough to cover increased risks.

As a result, insurers have resorted to reducing or restricting coverage, echoing the simplistic policies of the past. This transformation has sparked skepticism among consumers, who question the value of traditional insurance in light of escalating costs and diminished coverage.

In its simplest form, insurance is the transfer of risk. Consumers typically transfer this risk to an insurance company for a fee, but the current climate has resulted in more people looking for alternative solutions such as self-insurance.

In Florida, 20% of homeowners are doing just that, hoping to find some relief from bearing the highest home insurance premiums in the country. The average homeowner in the Sunshine State now pays more than triple the national average for coverage, which is why an increasing number are opting to fund the repair costs associated with any potential disasters themselves.

In regions prone to severe natural disasters like hurricanes or wildfires, or in areas that insurance companies deem uninsurable, individuals with substantial wealth often encounter difficulties obtaining insurance for their properties, despite having the financial means to buy them. There’s a misconception among ultra-high-net-worth individuals that investing in luxurious properties will automatically attract numerous insurance options. However, this belief doesn’t align with reality. The real estate market often overlooks and doesn’t fully disclose the risks linked to such properties, leaving potential buyers unaware of the implications.

Consequently, many homeowners in these areas opt for self-insurance. Although these property owners can afford lavish estates, they might lack the resources needed to maintain them, and this imbalance leads some owners to reconsider their choices.

In most cases, only people who own their homes outright with no outstanding mortgage are eligible to consider self-insurance. However, it’s important for individuals considering self-insurance to also consider the risks associated with forgoing a traditional policy, a responsibility that falls on the shoulders of wealth advisors and brokers to inform their clients.

Helping your clients understand the value of insurance

As insurance policies evolve and adapt to the changing world, advisors with clients contemplating self-insurance must tread cautiously, acknowledging the potential pitfalls and limitations associated with this choice. Here are three key points to share with homeowners that are considering self-insurance.

1. Policy coverage at all costs. The worth of an insurance policy transcends the dollar value associated with it. While a policy may cover a million-dollar home, the intricacies and additional clauses sometimes translate to coverage exceeding the initial estimation. Many self-insurers, on the other hand, may not be able to realistically afford a catastrophic loss, such as their home completely burning down or being impacted by flooding. In addition, with self-insurance there’s no protection from injuries on a homeowner’s property — and any accompanying lawsuits.

2. Strained contractor resources. In times of calamity, contractors might prioritize properties covered by insurance policies first, leaving self-insured individuals struggling to secure prompt assistance.

3. Absence of forecasting and risk mitigation. Without an insurance policy, there’s no link to a broker for forecasting or assistance in case of damages. In the event of a claim, the self-insurer is left to handle it independently. While some can afford self-insurance, many opt for traditional routes to access expert guidance and support during unforeseen events for precisely this reason.

Navigating toward the future

The future of insurance seems poised to revisit a simpler era, reminiscent of Ben Franklin’s days. As policies evolve, home technology improves and the cost of properties increases, insurance will follow suit. The coverage lines will change and adapt to meet the needs of the property owners and operators. From à la carte to full-service policies, the way of the future is to make sure homeowners’ property coverage is right-sized for their personal risk appetite, whether that moves a policyholder more toward self-insurance or other additional and unique risk transfer options.

Although it might seem financially prudent in some cases, it’s important to remind your clients that the absence of expert advice, connectivity to resources in times of need, and the sheer magnitude of unforeseen expenses can outweigh the perceived benefits of self-insurance. Although today’s insurance policies are different than in the past, the decision to resort to self-insurance demands careful contemplation, weighing the risks against the perceived savings.

Robb Lanham is chief sales officer, HUB Private Client. Contact him at [email protected].

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