What is a key disadvantage of self-insurance?

Self-insurance involves setting aside funds to cover possible losses instead of purchasing a traditional insurance policy. While it can offer benefits like cost savings on premiums, one key disadvantage is that it often provides limited protection against catastrophic losses. In a self-insurance model, individuals or businesses may find that they lack the financial resources to cover large, unexpected events, as the funds they have set aside may not be sufficient to handle such severe claims.

Unlike a traditional insurance policy, which pools risk across many policyholders and offers coverage for extensive damages resulting from catastrophic events, self-insurance relies on the entity's own funds. If a substantial loss occurs, the self-insured entity can face significant financial strain, risking insolvency or operational difficulties. Therefore, the limited capacity to absorb large losses distinguishes self-insurance as a less reliable option for comprehensive coverage against catastrophic events compared to purchasing an insurance policy.