Under certain conditions, it may be possible for a risk to be in­sured without transferring it to an outside insurer. When this is done, it is commonly referred to as “self-insurance.” An individual who self-insures must not be confused with a person who does not insure at all. Self-insurance is technical and requires the application of scientific insurance principles.

Not all risks which may be insured with outside carriers are in­surable under a self-insurance plan. A true self-insurance plan re­quires a large number of homogeneous exposure units under one ownership, so that losses can be accurately predicted. As a second requisite the exposure units must be independent of one another, in order to reduce the chance of a catastrophic loss. Finally, the life insurance company must be strong enough financially to meet adverse loss experience and to maintain adequate reserves.

The operation of a self-insurance plan calls for contribution to a fund of a regular periodic premium, scientifically calculated to pay losses when they occur. In years when losses are low, the fund will grow, only to be depleted in years when experience is bad. Since the years of bad experience might well come during the early years of the plan before the fund is built up, it is usually considered wise to install self-insurance gradually.

Thus, a decreasing amount of private insurance can be taken each year as the self-insurance fund in­creases. In this manner the insured can protect himself against heavy losses which come early in the plan’s development. When self-in­surance is used, it is often desirable to have some reinsurance or excess coverage with outside companies for all losses which exceed some basic figure.

How low or high this retention should be depends upon the financial position of the insured, the nature of the business, and other considerations. A financially strong company could carry its own affordable life insurance to a much higher limit than could a weaker com­pany.

One other point about self-insurance is important. Self-insurers must not overlook necessary loss-inspection and loss-prevention ac­tivities which, in some lines of insurance, are at least equally as important as indemnity itself. If a company is not in a position to provide or purchase this service for itself, it may be wise to insure outside.

Those few companies which can qualify might find it economical to use self-insurance. Because of lower administrative costs, self-in­surance may be less expensive than insurance with commercial com­panies. There are no selling costs and no premium taxes. Some of these savings, however, might be offset by an increased cost of engi­neering and claims service if the self-insured is not equipped to perform these functions as efficiently as they can be performed by commercial carriers.

A company with unusually favorable loss ex­perience might find attractive savings in a self-insurance program, since life insurance rates do not always fully reflect individual experience. Through self-insurance, the insured receives the full benefit for successful efforts in loss prevention.

Self-insurance is sometimes criticized as unsafe in the event of a catastrophic loss. This shortcoming can be offset by the use of excess insurance for shock losses. Finally, the management of self-insurance often is criticized as inferior to that offered by commercial insurance carriers. Where the self-insurer feels this to be true, he may employ the services of professional self-insurance management firms. A number of these service organizations are located throughout the coun­try.

There might be an income tax disadvantage in the use of self-insurance, for it is conceivable that self-insurance might create addi­tional tax burdens. Contributions to a self-insurance reserve are not a deductible expense under the income tax laws. Only losses paid from the fund are deductible. The result is that several years may pass with relatively light deductions, whereas there may be heavy deductions in other years.

Because of the graduated scale of tax rates, the net tax burden over a period of years might possibly be less if an average annual tax deduction could be taken (assuming, of course, that earnings are also relatively stable). This is possible un­der insurance with a commercial carrier, since premiums paid to these carriers are deductible for tax purposes in the year paid. If an­nual premiums are constant, the insurance deductions for income tax purposes also will be constant.

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