Gui de to Self-Insurance

Most people manage risk by purchasing insurance, which effectively allows you to pool the risks with others, and therefore allows each person to pay a smaller premium under the theory that all the people in the insurance pool won't be claiming at the same time.

There are occasions however where you can't get insurance - eg if you are in a flood-risk area, or if the premiums are just too high compared to the benefit you are getting from the insurance.

Self insurance involves you setting up your own reserve to pay for liabilities that arise. People are often surprised to find that they do this already - rainy day funds set aside against unemployment are a form of self-insurance. Essentially with self-insurance, you are bearing the risk yourself, rather than offloading the risk onto an insurer in exchange for a premium.

First of all you need to carefully assess the circumstances where self-insurance is more cost efficient than paying an insurance premium. Here's a list of circumstances where this is the case:

1 Car Insurance UK law insists that you must have at least third party car insurance. Most people carry comprehensive insurance though, and I definitely think comprehensive insurance is preferable to third-party insurance, as the roads are dangerous.

However, you can reduce your insurance premiums by increasing the "excess" or deductible, and self-insure for this amount. The "excess" is the amount not covered by the insurer, eg the first £100 of the claim. Set up a savings account where you get a good level of interest paid and pay in the amount equal to the excess/deductible. Don't touch this money for ordinary purposes. The mistake many people make is to opt for a large excess to save on the insurance premium, but they don't set aside the money, which means that when they actually have to claim, the excess hits them hard. You can then carefully increase the amount of the excess year by year, as you increase the savings in your self-insurance account, and get your insurance premium reduced.

2 House Insurance - house insurance has the same excess/deductible options as car insurance. Again the principle is the same. Set aside the amount of the deductible in a savings account, and as you increase the savings, increase the amount of the deductible and save on the insurance premium you pay.

3 Unemployment insurance. The unemployment insurance policies sold in the UK are absolute rubbish in that they are hedged with caveats and don't usually let you claim except in unusual circumstances. Self-insurance is definitely the better option here. First work out how much you need to be able to live on for at least three months. Then work out how much you would be able to claim in state unemployment benefit, and subtract this amount. The remaining total is the amount you need to build up in your self-insurance fund. Again, don't touch this fund for any other reason than the one it was set up for.

4 Americans often have to take out medical insurance, as their government does not provide health care. Again, these policies usually have deductibles, and you can increase the deductible and reduce your premium by carefully setting aside the amount of the deductible in a savings account.

5 Many people who live in flood plains in the UK have found that they can't get flood insurance . According to the Environment Agency about 2.3 million homes are built on flood plains. Obviously if you have a choice, don't buy on a flood plain - check out the Environment Agency's website to see if you are in a flood-risk area. The risk of flooding will increase as the climate gets warmer, as warm climate usually means heavy rainfall, rather than the gentle drizzle we've been used to. Unfortunately, most of the flood-risk towns are of long settlement, like York or Tewkesbury (which is at the confluence of the Avon and the Severn), and if you are born and live there... well you have to find a way to cope. Here's some ideas on how to prepare for flooding:

• Lobby your council to get flood defences for your town - it's well worth putting in the effort and going to dreary public meetings and pushing to get this done. You'll be grateful in the long run.

• When there is a sign that flooding might start,

• Buy some sandbags and store them in the garage for a flood emergency. When it happens, place the sandbags on the outside of the house around all the openings.

• You can buy free standing plastic skirts to place outside your house - see the environment agency's website

• Buy silicone sealant and smear a layer of it round window and door frames and then lock and shut windows and doors

• Cover doors, windows and air bricks with sandbags, plywood or metal sheeting

• Unplug all electrical devices and store them as high as possible. Turn off water, gas, and electricity supplies at the mains.

• Make sure you have emergency supplies of bottled water.

• Move furniture away from the walls.

• Roll up carpets and put them upstairs

• Keep important documents in plastic and store them upstairs.

• Make sure you have lawns in front and back of the house - it means water can soak straight into the ground rather than building up on the surface

• Remember that your car is also at risk in a flood. Park it on high ground, or put it in the garage and make sure you stack up sandbags around the garage door.

• Build an emergency fund - the average flood insurance payout is about £15,000 to £20,000. Which is a lot of money. If you can't get flood insurance and can't move to a safer part of the country, you have no choice but to bite your lip and start saving.

The important thing about self-insurance is to make sure that you are fully aware of all the risks you are taking on and make sure you do everything you can to minimise the risk. Then set aside adequate amounts of money, make sure it is easily accessible and safe, which means a high interest savings account - don't gamble this money on the stock exchange, as shares can go down as well as up, and a downturn might co-incide with the point you need to access the money. Don't be tempted to touch this money for anything other than the purpose it has been set aside for, and when you do have to draw out money to meet a liability, remember to build up the fund again.

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