June 27, 2018

Insurance, self-insurance and the art of crossing your fingers

Written by Rob Hartley

Dinghy Co-Founder

Insurance: a word that conjures joy in some, revulsion in others. Something that everyone uses yet no-one wants to talk about.

I wrote this article because so many people ask why they need insurance. Even though pretty much everybody in society buys insurance in one form or other, it is something that is misunderstood and purchased in a grudge.

I find this so upsetting…How can so many people buy something and not understand it? How can something so fundamental to society be something people don’t like? It’s like buying a car and having it delivered to you, but you leave it on the street and don’t drive it as you don’t know how. Year after year, it just sits there, until you swap it for another one. Insurance shouldn’t be this way. Not only is this a personal plight for me; but at Dinghy, we want to change this perception and make insurance a social good again.

So my challenge to you is that by the end of this article you will be better informed and feeling great about insurance. You will see that it can be a source of good and helpful in a time of crisis, and you will be able to choose whether you want to insure, self-insure or just keep crossing your fingers and hope nothing happens.

How can I achieve all of that in a single article? You’ll find out by the end! To give you a sneak preview, we will cover and explore:

Are you ready? Let’s go!

What is insurance?

The basis of insurance is to put you back as close as possible to the position you were in before an accident happened. This could be by replacing your car that was damaged, or paying a doctor to fix a broken leg.

Sometimes it’s impossible to put everything right, so then insurance also pays to make changes to make your life as manageable as possible. For instance, if you were left without an arm in an accident, then your car could be adapted for you to be able to drive it still. This principle of putting things right is called indemnity.

There is one insurance that doesn’t follow the rules of indemnity…can you guess what it is? If you said life insurance, then you’re right! Sadly there is no amount of time or money that can bring you back to life. As such, life insurance is a non-indemnity insurance.

The other side of indemnity is not to over-compensate. The best way that I can get you to remember this is by referencing Doctor Who and the Cybermen. How many readers watch Doctor Who? If not, Cybermen are one of the enemies on a mission to upgrade humans into cybermen…pretty scary stuff!

What do Cybermen have to do with insurance? The principle of indemnity is to put you back to the position you were in before the claim; it doesn’t leave you worse off, but just as importantly it doesn’t over-compensate you…or, in other words, it doesn’t upgrade you!

For instance, if you have an iPhone 7 and it needs replacing, your insurer will give you a replacement iPhone 7. You won’t be upgraded to an iPhone 10.

Unfortunately, a lot of people don’t understand this. Amazingly insurance companies see a rise of mobile phone claims every time a new iPhone is released. Customers with the older model wrongly believe they will be able to get the latest model if they make a successful claim. But even if their claim is valid, they will only receive a replacement older model – they have then been indemnified, not given an upgrade.

So remember, insurers are not Cybermen!

A brief history of insurance

The first insurance policies evolved around 3000 BC. It’s hard to pin down, but there are recorded stories of ancient China, Babylonians and Phonecian merchant sailors creating pools to look after each other. They each put their hard earned cash into a communal pot. Then if anyone’s boats were sunk at sea or pirated raided their goods, they could compensate each other. This type of mutual boat insurance still exists today, and is going through a resurgence at the moment with the rise of so-called “peer to peer insurance”. However, at its core, all insurance is really a peer-to-peer model where the premiums of the many pay the claims of the few.

Let’s speed forward to the late 1680s and into the City of London. Amongst the hoarding crowds, street hawkers and chickens running around, we find a group of people sat in a small coffee shop, owned by Edward Lloyd. It might not have had a name, but we’ll call it Lloyds Coffee Shop for the purpose of this blog. Whilst Mr. Lloyd served their coffee, these men were discussing the very same concept as the ancient Phoenicians and Chinese. How do we pay for the loss of our merchant boats, crew and stock? They decided to form a Syndicate of cash to pay for each other’s losses.

Before long more boat owners wanted to become part of this Syndicate arrangement or form their own, and they were told to go and meet at Mr. Lloyd’s coffee shop of London. More people arrived, more syndicates were born. The meeting place name became shorter and snappier – until it was simply known as Lloyd’s Of London. A name that stays true to this day (even if they have outgrown the coffee shop).

As insurance has evolved, a multitude of different products covering everything from pet armadillos to freelance zoo-keepers; all with different excesses, limits, commissions and fees have appeared.

Unfortunately, in the process, it has become easy for some people to hide terms in small print that make it hard for customers to claim, or include inflated fees simply to maximise profit.

Greed has crept into insurance, and while the regulators and the government will try and close off loopholes, the greed has clouded a lot of insurance and created an air of distrust between customers and insurers.

But I ask you to clear your mind of that distrust, and just focus on the basic concept. That insurance is there to help if something goes wrong. That is what we are focussed on, and that is why we have built the company we have – to re-introduce transparency, fairness and openness back into the insurance industry.

Why should I buy insurance?

As discussed above, general insurance is a service to indemnify you when something goes wrong. So if you feel that you can put yourself right after an accident, then you don’t need insurance.

To take an example let’s look at property insurance. We’ll start with property insurance as it’s the most tangible and real. At Dinghy we provide freelancer’s business equipment insurance – this covers everything that you need to run your business, such as your laptop, phone, desk, printer, camera etc.

Before you can decide whether or not to buy insurance, there are two questions that you need to ask yourself:

    • How likely is it that I will damage my equipment beyond repair, someone will steal it, or it will be damaged or destroyed by fire?
  • Can I afford to replace my equipment if anything does happen to it?

If the answer to the first question is there is no risk, or a very small chance of it being damaged, then all is good. Equally, if the second question is “yes I can easily replace this”, then insurance would not be right for you.

For instance, let’s say you have a waterproof, shock resistant mobile phone that you’ve had for a few years. The chances of damaging it are low, it’s not very attractive to thieves and the cost of replacing it is low. So insurance probably isn’t right for this item. However, if like me you have an expensive smartphone that loves to fall from your fingers, then insurance is definitely worth considering.

The second part is even more critical than the first. If you have a laptop worth £2,000, can you afford to replace it at a moment’s notice? Without insurance you will need to go and buy a replacement. If you take out a loan or buy it on a credit card, the monthly repayments will be significantly higher than an average insurance premium.

You may be wondering, how is it possible for an insurance company to replace your laptop much cheaper than you can…which leads me neatly on to:

The premiums of the many pay the claims of the few.

Remember the way insurance started? With groups of traders pooling money together to look after each other? Well that’s still how it works today, it’s just you don’t know the other customers in your insurance company. By having a large volume of customers, insurance companies can spread the cost of a claim across everyone meaning that everyone has a reasonable premium.

When you choose to self-insure, or simply keep your fingers crossed and hope nothing happens, if you have a claim then you don’t have that pool of money to help pay for your claims. You have to reach into your own pocket and find a significant cost outlay there and then.

Aren’t all insurance companies super rich and ripping us off?

Some people feel that insurance companies charge too much and are taking way too much profit. That they deliberately overcharge in order to make huge profits at our expense. As we read earlier, it is true that there are certain aspects of insurance where greed has come in – excessive broker placement fees, cancellation fees, big data abuse to overcharge one customer versus another…but that’s not true of the whole insurance industry.

Insurers absolutely need to make a profit, not only to make sure they can be around in the future to pay your claims, but also to deal with one of the problems of insurance – its unpredictability. One year there may be very few claims; the next there may be a flood and millions of pounds worth of property damage. So insurers need to keep money aside from the good years, to pay for the unexpected claims in the bad.

For instance in 2017 there were several hurricanes in the Caribbean and North America. These caused billions of pounds of damage.

So much damage was caused that one insurance company ended up losing 38p on every £1 that they insured. To put that into context; for every £1,000,000 of premium they took in, they paid out £1,380,000! The reason they didn’t go bust is because they had built up a reserve fund to make sure they could cope if this event happened.

So while there are dodgy firms out there, it doesn’t mean that all insurers are ripping us off. However, be careful of the rogues. Look out for the excessive greed and the hidden small print; look out for excessive fees and high excesses – and come to insurance companies like us at Dinghy where we make insurance simpler and easier to understand.

Self-insurance for the freelancer or small business

Given all that you now know of insurance, hopefully you are in a great position to know whether or not to buy insurance or not.

If you decide not to buy insurance, then you have the choice of either doing nothing and keeping crossing your fingers… or putting money aside for a rainy day. If you are putting money aside to cover expected losses then we call this self-insurance.

In my opinion, there is no point in a freelancer or a small business trying to self-insure. The risks are too great and the potential costs too high, Also insurance premiums are classified as a business expense, which means you pay for your insurance before tax; whereas if you put money aside for self-insurance, you will have to do this out of your profit after tax.

If we look at Professional Indemnity insurance or Public Liability insurance, the costs can be too great for any small business to safely set aside money for. With Public Liability insurance the minimum you can purchase is £1m. The reason is because if someone is hurt by something you’ve done, the cost of their medical bills, potential lost work costs for time for recovery, and their compensation can be substantial and easily run into the hundreds of thousands of pounds. Any small business or freelancer cannot truly afford to offset these costs. Also, if you are a sole trader you are potentially exposing your own personal assets for paying insurance claims.

With Professional Indemnity insurance, the concept is the same. However, even if you just needed to hire a lawyer to defend you against any allegations this could become a huge cost. An average lawyer can charge £300 an hour to review your case. A couple of weeks work simply to defend you against allegations can amount to a significant amount of money.

This is one of the reasons we started Dinghy. To provide freelancers with simple to understand and affordable insurance for their business, so they don’t have to run the risks of self-insurance. But also go a step beyond and provide additional benefits like access to a 24/7 counselling helpline.

Self-Insurance for mid to large companies

Larger companies have a different balance sheet and cost basis. Huge international operations can find cost savings through self-insurance. For instance, BP actually own one of the largest insurance companies in the world – Jupiter Insurance. This insurance company is different to most as it only insures the risks of BP themselves. This type of insurer is a captive insurer. Why have BP self-insured through a captive insurance company? Because they found that with their substantial balance sheet they could afford to self-insure the risk versus trying to buy insurance on the open market.

This doesn’t mean that captive insurance is out of reach for some companies. Various mechanisms are now in place to make self-insurance easier for mid to large size companies and associations, such as Protected Cell Companies (PCCs) and Risk Retention Groups (RRGs).

It would be out fo scope for me to dive into these types of areas in too much detail in this article. But if you work in a mid-size company it is well worth spending some time looking at your options for self-insurance.

As a word of caution; there are still management costs associated with running a self-insurance vehicle such as a captive; and normally it will have to purchase its own insurance, called reinsurance. As such, these additional costs can end up making the cost-benefit marginal compared to buying insurance from the traditional insurance market.

Sum-up

You have three choices when it comes to business insurance: buy insurance, self-insure or simply keep your fingers crossed and hope!

In my opinion, it makes no sense for a small business or freelancer to do anything but buy insurance. The industry has been tarnished by too much greed in recent years, but the time is now for a comeback to the proper days of insurance as a means for social good and looking after people in a crisis.

Keeping your fingers crossed is just too risky; and self-insurance doesn’t make financial sense. For larger companies it is something worth considering and discussing with an insurance broker who specialises in this area.

It would be great to hear what you think of this too: Do you buy insurance? Did I hit the target and help you understand insurance better?

Feel free to comment below or open our live chat and discuss with us!

About Rob Hartley

Rob Hartley ACII has worked in insurance for over 17 years in Europe, USA and the Caribbean. He is inspired to improve the image of insurance and bring it back to being a social good. Having also worked as a freelance web developer and an insurance consultant he is passionate about improving insurance for freelancers. In 2017 he co-founded getdinghy.com, an insurance provider that specialises in freelancer insurance.

Read more blog posts by Rob Hartley


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