Why Self-Insurance Rarely Works
I’m frequently told by people that they’ve been advised by others to skip traditional insurance and simply set up an effective sinking fund: a little reserve where you accumulate all of the insurance premiums you would have otherwise paid to the insurer, using those as your insurance or ‘rainy day’ fund.
In theory, if you’re the average person in the average city receiving all the average results, you remove the middleman and come out ahead financially. It’s an appealing concept that sounds sensible on paper.
However, there are several fundamental problems with this approach.
The Friend-of-a-Friend Phenomenon
Here’s something I’ve noticed: it’s always a friend of a friend who tells the person that self-insurance is a wise call, or they know someone who knows someone that does this successfully. You never actually meet these people, funnily enough.
And of course, for those where it’s been spectacularly unsuccessful, and I’d wager there are far more of these, they’re hardly going to put it on their social media feed or tell their friends about their ill-fated strategy over coffee. It’s the ultimate example of survivorship bias: we only hear the success stories (usually second or third-hand), never the cautionary tales.
I suspect I know why we never meet these successful self-insurers: they simply haven’t had their catastrophic year yet. They’re still in the accumulation phase, feeling clever about their growing balance, not yet tested by the kind of year that wipes out decades of savings in twelve months.
Behavioural and Inflation Challenges
Human nature works against the sinking fund strategy. Behavioural economists have documented what they call “present bias”, our tendency to prioritise immediate needs over future uncertainties.[1] Research from the Financial Markets Authority shows that New Zealanders consistently overestimate their ability to save regularly and underestimate their spending.[2] A “set and forget” sinking fund sounds perfect in theory, but that account becomes the first place people raid when unexpected expenses arise.
There’s also the “optimism bias” at play. Studies consistently show that people believe negative events are less likely to happen to them than to others.[3] This leads to underfunding self-insurance reserves or abandoning them altogether when nothing goes wrong for a few years.
The inflation problem compounds these behavioural challenges. Not all inflation is equal. Medical inflation is far greater than domestic core inflation, to the level of 7.2 times at present, according to recent analysis published in Business Desk.[4]
Construction costs tell a similar story. According to Stats NZ’s Capital Goods Price Index, building costs increased by approximately 42% between 2014 and 2024, while general CPI rose by only 24%.[5] Many New Zealanders only discovered the true cost of construction inflation during Cyclone Gabrielle, when they went to replace their homes. What they thought might cost $300,000 to rebuild suddenly became $450,000 or more.
Your sinking fund may grow at 2-3% annually through interest, while the actual costs you’re protecting against rise at 10%, 15%, or even higher rates. You’re essentially running backwards on a treadmill.
A Personal Reality Check
Let me share my personal experience from the last year, a year I thought would be utterly unremarkable.
I considered myself pretty average: late forties, fit, healthy, gainfully employed and married with kids in their teenage years. We have two cats, one dog, five coloured pet sheep. Our home is well-maintained, no deferred maintenance. My car was serviced on schedule. We have regular health check-ups. Nothing special, nothing unusual.
We are exactly the people you'd expect to sail through the year without incident. Then reality intervened.
First, rats ate out the wiring and suspension system on my car, rendering it completely inoperable. Six weeks in the repair shop. The bill: $18,000.
Then, while out of town, a water cistern in the roof of our home failed, a small $1.20 rubber washer perished, and water came down through the walls and spread across multiple rooms. Wall damage throughout multiple rooms and full carpet replacement due to staining. Four weeks of repairs. The claim: $55,000.
Finally, last month, a small mole on my wife’s leg led to surgery, five nights in hospital, and a health insurance claim of $28,500.
Three unrelated incidents. One year. Total claims: over $101,500.
So much for being average. Even if I’d been religiously funding a sinking fund for twenty years at $5,000 per year, which would require extraordinary discipline, I’d have accumulated $100,000. This single year would have wiped me out completely, leaving me to start from zero at age 49.
That assumes I never once raided the fund for other “emergencies” over those two decades. In reality, most sinking funds would have been depleted long before reaching six figures.
The Fallacy of ‘Self-Insurance’
Let’s put this in perspective: according to Stats NZ, the median household income in New Zealand is around $108,000.[6] My insurance claims for the year essentially equalled an entire year’s median household income, before tax. Even high-income households would struggle to self-fund this level of claims, let alone maintain their standard of living while doing so.
According to the Insurance Council of New Zealand, the average house insurance claim in 2024 was over $15,000, while the average health insurance claim requiring hospitalisation exceeded $20,000.[7] These aren’t amounts that most sinking funds could absorb, especially early in their accumulation phase.
The Commission for Financial Capability found that nearly 40% of New Zealanders would struggle to cover an unexpected $1,000 expense.[8] If we can’t maintain buffers for small shocks, expecting people to maintain funds for potentially catastrophic events is unrealistic.
A Better Solution: Employer-Sponsored Insurance
There’s a middle ground that addresses many of these behavioural and financial challenges: employer-sponsored group insurance schemes. When a company pays for insurance as part of an employee’s remuneration package, it eliminates the temptation to raid the fund or skip payments. The coverage is there, consistently, without requiring ongoing willpower.
One of the most significant advantages of group schemes is that they typically provide cover for pre-existing health conditions – something that can be difficult or impossible to obtain through individual policies. This means employees who may have previously been uninsurable can access comprehensive coverage.
We practise what we preach; our business has provided health, life, and trauma insurance packages as part of our employment package for over a decade. Leading by example, we’ve seen firsthand how this removes the burden of decision-making from employees while ensuring they’re genuinely protected. The group purchasing power also means better rates than individuals could access on their own.
Why Insurance Endures
There’s a reason why insurance has been around for many millennia. It’s because pooling risk across large populations is the only mathematically sound way to protect against catastrophic but unpredictable losses.
When you pay insurance premiums (personally or through an employer scheme) you’re not just paying for potential claims. You’re paying for certainty, for protection against the extreme tail events that can derail your financial life, and for a system that removes the behavioural challenges of self-discipline and forced saving.
Self-insurance sounds empowering and financially savvy. But for most New Zealanders, it’s a gamble that looks good until the moment you desperately need it to work… and discover it doesn’t. The gap between what we intend to do and what we actually do is where self-insurance strategies collapse, leaving people exposed precisely when they need protection most.
My $101,500 year proved that beyond any doubt. Which is why any credible financial plan must include adequate insurance coverage. If your financial adviser isn't discussing insurance protection alongside investment strategy, you're not getting comprehensive advice: you're getting half a plan.
Nick Stewart
(Ngāi Tahu, Ngāti Huirapa, Ngāti Māmoe, Ngāti Waitaha)
Financial Adviser and CEO at Stewart Group
Stewart Group is a Hawke's Bay and Wellington based CEFEX & BCorp certified financial planning and advisory firm providing personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver scheme solutions.
The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from a Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
Article no. 436
References
[1] O’Donoghue, T., & Rabin, M. (1999). “Doing It Now or Later.” American Economic Review, 89(1), 103-124.
[2] Financial Markets Authority. (2021). “Understanding Financial Capability in New Zealand.”
[3] Weinstein, N. D. (1980). “Unrealistic optimism about future life events.” Journal of Personality and Social Psychology, 39(5), 806-820.
[4] Business Desk. (2024). “Medical inflation outpaces general inflation by factor of 7.2.”
[5] Stats NZ. (2024). “Capital Goods Price Index and Construction Price Index.”
[6] Stats NZ. (2024). “Household income and housing-cost statistics: Year ended June 2024.”
[7] Insurance Council of New Zealand. (2024). “Annual Claims Data Report.”
[8] Commission for Financial Capability. (2023). “Financial Resilience in New Zealand.”