Self-Insurance

The losses are numerous, predictable, and noncatastrophic, so the employer can budget for them — Retention — including self-insurance — works best when losses are frequent enough to be predictable and small enough to be affordable without threatening the firm's survival. A large employer can estimate its annual claims using its own experience and the law of large numbers, then budget for them. Retention is inappropriate for rare, catastrophic losses that could wipe out the firm; those are transferred to an insurer, often with stop-loss coverage. Self-insurance also requires scale to achieve predictability.

National insurance concept

Retention of small losses and transfer of large losses — The corporation is combining two risk-management techniques. It retains the predictable, affordable small losses by paying them from operating cash, while transferring the large, potentially catastrophic losses to the insurer through the policy above the deductible. This layered approach is economically rational because small losses are frequent but cheap, whereas large losses are rare but financially dangerous. Retention and transfer are complements rather than substitutes, and the deductible is the boundary between what the firm keeps for itself and what it shifts to the insurer. This structure is sometimes called self-insurance combined with catastrophic coverage.

National insurance concept