A WHITE Paper!

A Primer On Risk Management
and Business Insurance

Overview

Designing a program of protection for your business is a three step process. First, you need to determine what risks your business faces. Second, you must prioritize those risks.  And the third step is to determine what type of insurance policies will protect you from the risks you identified.

Let’s start with steps one and two, which are called Risk Management. Then we’ll look at the basic forms of business insurance.

Risk Management 101

The Short Course
Risk management is a term that gets a lot of play in business publications.  And I do not want to under emphasis how important it is for a business.  But it does not have to be as complicated as some writers make it. So let’s keep it simple. Here are three simple steps for evaluating business risks:

1. Insure the unknowns. For instance, you can define the risk of losing a truck worth $10,000.  If you lose the truck, you lose $10,000. But you can’t define the cost of the damage that truck can do to others, if it is in an accident. That risk can be millions! So dealing with the damage your truck can do to others is more important than the damage to your truck.
2. Determine the things you are required to insure. Your bank, mortgage company, or other contractual agreements may require you to insure certain things. For instance, you may choose to finance your $10,000 truck. If so your bank may require you to insure the truck for physical damage because it is collateral for your loan.
3. Finally, insure the things that your business can not afford to pay to replace if they are destroyed. Let’s use the $10,000 truck as an example again. But now let’s assume you paid cash for the truck. No one is requiring you to insure it.  If it is destroyed, can you afford to replace it? Must your business have a truck to make deliveries? If your answer is yes to these questions, consider insuring it.

So now you have some idea about the types of risks your business might face. How do you deal with the risk of loss? Here are the most common ways to deal with risk:

• You can assume the risk. For example, if your business uses inexpensive needles that break often, you would not want to insure them. You just assume that risk. Replacing the needles is a risk you can afford to “self insure”.
• You can avoid the risk. If you are a contractor that installs kitchen floors, you may choose not to install a new floor until the old asbestos floor is removed by a contractor specializing in asbestos removal. This way you effectively avoid the risk and the expense associated with it.
• You can minimize the risk. Your business may require your employees to use power tools. In this case you can not totally remove the risk to the employee or the risk to others. But you can minimize it. You can train each employee on the safe use of the tool. You can make sure all the tool’s guards are in place.  And you can restrict the areas in which the tool is used. There is still some risk but you have done your best to limit it.
• Finally, you can pass the risk to others.  You can pass risks to others by contract or insurance. Contracts are the most common method of risk transfer.  For instance, you may enter into a contract to have another party do part of the work for a customer. The contract will require your “subcontractor” to “indemnify” you from any accident or damage arising out of their work. The second method is an insurance contract. You pass can all types of risks to an insurance company. In fact, without insurance many businesses could not exist. The risks and the cost of assuming the risk would just be too large.

Insurance
The Ultimate Risk Transfer Tool

Now let’s deal with insurance. Thousands of businesses can simplify the insurance buying process because they qualify for a Business Owners Policy. It is commonly called the BOP. A BOP combines several types of insurance into one neat package. Let’s start with it first.

The BOP
The policy not the dance!

BOP’s are great buys for most small businesses. They provide broad insurance protection at a low cost. A BOP is an efficient way for the insurance company to package several policies together.  So you get a better buy and better protection. Plus, BOP’s can be written for thousands of different types of businesses.

So what do you get with a BOP?  All BOP’s are slightly different. Each insurance company targets their BOP to appeal to the kind of businesses they want to insure. But a typical BOP will include protection for your business property (building), protection for your business personal property including theft (building contents, machinery, and mobile equipment), protection for your computers and software, protection from dishonest employees, and liability insurance to protect you from lawsuits.

BOP’s are usually priced based on the total value of property and business personal property the business owns, leases or rents. The larger the values insured, the larger the premium. Some BOP’s are rated on the gross sales of the business.

Here are the BOP policy advantages:

• Low price for the protection provided.
• Basic or Broad Coverage options are customized for your business.
• High limits of protection are available.
• One policy covers many types of exposures for your business.
• Thousands of different types of businesses qualify for a BOP policy.
• Most BOP’s can be paid for on an installment basis with no interest.

So the first thing to ask your agent or broker is, “Will my business qualify for a BOP?”

A good agent will ask you many questions to try to determine which BOP best fits your business and your budget. An independent agent or broker will be able you to furnish you with BOP quotations from three different insurance companies. That will give you a good feel of the market place and it should be easy to pick out the best buy. This also means you do not have to have multiple agents provide quotes which can be confusing and time consuming.

One caution, your small business may still need a separate auto policy, a workers compensation policy or a specialty policy of some sort to fully provide the protection your business needs.

The Commercial Insurance Package
When Separate Policies are Necessary

Although the BOP is an exceptional insurance value, not every business will fit. For larger businesses or businesses ineligible for a BOP, the business owner and their agent must design a “package” of insurance products to protect the business.

A basic business insurance protection program consists of six insurance categories. They are Business Automobile insurance, Commercial General Liability, Umbrella or Excess Liability, Workers Compensation and Property insurance. There are many specialty products under these key categories. Don’t let all the fancy terms scare you. I’ll break each down for you as we go along.

Be aware that there are hundreds of policy modifications available for each type policy. Policies are rarely issued without modifications. These modifications are known as “endorsements”.  Typically, a policy endorsement limits or expands the protection provided by the policy. The endorsements tailor the policy to the specific needs of the business.

 Automobile Insurance

There are two types of Business Automobile insurance. The first protects the business from the legal liability it might incur due to the injury of other parties or their property, which results from the operation of any business automobile. Whoops, that last sentence was written in “insurancese.” Sorry! In plain English, what I meant to say was, if you accidentally hurt someone or damage someone’s property with an automobile, the insurance company will step in and pay for the damage. The second kind of Business Automobile insurance repairs damage to the autos you own, rent, lease or borrow.  These two kinds of protection make up the basic Business Automobile Policy (BAP).

Businesses may operate very specialized equipment. Some equipment is both equipment and automobile. This depends on its use. An example would be a mobile crane. The crane is an auto when the stabilizers are up and it is moving over the road. When the stabilizers are down and the crane is in use, it becomes equipment. So be sure to tell your agent about all the mobile equipment you own. The agent can then make sure you are properly insured.

If a small business is going to have a large claim, it most likely will be due to an auto accident, so consider at least a $1,000,000 limit for Business Auto insurance.  

Commercial General Liability Insurance

The Commercial General Liability (CGL) policy offers your business a lot of protection. A simple summary of the entire policy is: The insurance company will pay if your business is legally liable for physically hurting someone or damaging their property.

 Of course, there are exclusions in all policies and this one has exclusions, too.  I usually encourage clients to read the policy exclusions before reading the body of any insurance policy. If you clearly understand what is not covered, you’ll understand what is covered. Besides some exclusions can be removed. But you got to know they are there before you can ask your agent to have them removed!

Such things such as acts of omission, errors and workmanship are specifically excluded from the Commercial General Liability policy. For instance, if you are a dentist and pull the wrong tooth, don’t look to this policy to provide protection from the patient’s lawsuit!  A claim of this sort  is  an error…ouch…and a painful one for everyone since it is not covered by the CGL  policy. The good news is there are policies available for these type claims.  In this case, the dentist would need a Professional Liability Policy to cover his error for pulling the wrong tooth. He would still need the CGL policy to cover accidental bodily injury such as a patient injured by slipping on a wet floor in the lobby.

The Commercial General Liability policy also provides personal injury (libel and slander), advertising injury and some special contractual liability. I will not bore you with the details of everything covered. Your agent will be eager to tell you about all the protection included. Just remember, the key protection is for bodily injury or property damage to others caused by the business or the products of the business.

Premiums for this kind of policy are usually based on payroll, or gross sales. The larger your payroll or gross sales, the larger the premium will be.

You should consider investing in high limits of liability insurance. After all, we do live in a litigious society. But there is a cheaper way to buy higher limits of liability insurance protection. It is called an Umbrella policy.

Umbrella Liability Insurance-Cheaper by the Million
In the early 1950’s a catastrophic liability policy was developed. Originally, it was called a  Bumbershoot  policy!  That’s British slang for “umbrella.” The Umbrella name stuck because the Umbrella Liability policy extends over the limits of all the underlying liability polices.

What this means to you is an Umbrella liability policy is a cheaper way to buy higher limits of liability insurance protection. Here is how it works: The Auto Liability or the CGL are the first policies to respond to a liability claim.  If the claim does not exceed these policy limits the Umbrella policy is never activated.  The Umbrella’s cost is much less than the underlying policies because it only comes into play on very large claims. So it literally is cheaper by the million!

The Umbrella Liability policy is sold in increments of $1,000,000.  The Umbrella will usually extend the limits of the CGL, the Auto Liability and Employers Liability section of the standard Workers Compensation policy. (Example: Your underlying Automobile Liability policy limits are $1,000,000.  If you purchase a $2,000,000 umbrella, your total Auto Liability protection is now $3,000,000. Plus there is a bonus: the Umbrella will also provide increased limits for the CGL and the Employers Liability section of your Workers Compensation policy.)

A percentage of the underlying premiums for all other liability polices is used to develop the premium for the Umbrella Liability policy.

Since the Umbrella Liability policy is relatively inexpensive and it provides coverage for catastrophic liability losses, it is one of the most important risk management tools for small businesses.

Workers Compensation- A Must for Every Business

A business without this protection is a business at risk!  It is not inexpensive protection. In fact in some businesses, it is the most expensive form of insurance purchased. So it pays you to carefully evaluate Workers Compensation insurance. You need to understand what drives the cost. And you need to understand why this type of insurance is so important.

Workers Compensation insurance is a form of no fault insurance. It has its roots in the industrial revolution. Prior to the development of the Workers Compensation concept, an injured worker sued the employer to recover medical expenses and damages. The employers depended on certain common law rights to defend themselves.  Safety programs and  safety equipment did not exist. This led to frequent and dramatic employee injuries.

Labor wanted fair compensation for injuries and a safer work place. Industry wanted some way to predict and control costs. The court system failed to provide equitable solutions for the employers and the laborers. Labor and industry needed a fair and predictable solution, and the Workers Compensation concept was born.

Under the Workers Compensation system, business owners give up their common law defenses. They agree to depend on insurance to pay the worker’s medical bills and any disability suffered. Employees give up their right to sue in exchange for the benefits paid by the insurance. The legislative process allows both parties input into the amount of benefits payable and the cost of the insurance. A government agency then oversees the application of costs and payment of benefits. A government agency also oversees the insurance companies that provide the coverage to employers. Although Workers Compensation insurance evolved over the years, the basic concept remains unchanged today.

Workers Compensation insurance rates vary by State and by the type work the employee performs. The premium is determined by multiplying gross payroll by the rate for a particular labor class. An employer’s loss history may influence the final rate charged. If losses are infrequent and small, the premium will be less than a business with frequent and larger losses.

You should maintain Workers Compensation insurance because failure to do so can result in the demise of your business. Think about this a moment, if one of your employees is seriously injured, can your business pay the medical bills and a judgment for permanent disability until that employee dies?

The State may not mandate that you purchase Workers Compensation until you get to a specific number of employees. But that does not mean you are not legally responsible for the injury and permanent disability of an employee.

Workers Compensation is the only insurance policy with no limit!  And it is really two policies for the price of one. Part I is the part that pays for the medical expenses, rehabilitation and disability of the injured employee and it has no limit. Part II of the policy pays for occupational injuries or illness which may not be covered by the Workers Compensation laws in your state.

I know of no other form of insurance that pays for the occupational injury or illness of an employee! So think twice before you go “bare.”

Property Insurance

Property insurance is one of the oldest types of insurance. It has many forms. For instance, there are property forms that insure real property, business personal property and mobile equipment just to name a few.

New forms of property insurance are routinely developed. In addition, old policy forms are modified to include new types of property, Just think for a moment of the new types of property that have developed due to technology. Computers, MP3 players, e books, satellites, manufacturing robots, specialized mobile equipment and flying drones are just a few examples of property that came into existence due to technology. Property insurance policies are developed or modified to include protection for these new forms of property.

Property rates vary depending on the type of property insured, how it is protected and the value of the property. You can influence the cost of property insurance in a number of ways. For instance, installing a burglar alarm may reduce the cost of your property insurance. Or you might take a larger share in a potential loss by agreeing to a large deductible.

Landlords, banks, mortgages and other contractual relationships may require you to purchase property insurance since they stand to lose if the property is destroyed. They may want you to have your agent confirm to them that insurance is indeed in force on the property in which they have an interest.

Summary

I hope this Primer is helpful to you in deciding what insurance protection your business may need and how to quickly evaluate your business risks. It is likely the BOP policy will fit your needs. It is a good buy and you get a lot of extra protection at an affordable price. If you decide your needs go beyond the BOP, you’ll need to consider one of the other stand alone policies. In either case, I urge you to consider the services of a professional agent or broker.  A professional agent can guide you through the forest of insurance products (and hype!) and tailor a program that is just right for your business, your risk appetite and your budget. 

Caution: No brief summary of business insurance can fully explain or review all the issues necessary to evaluate the risks a specific business faces. Mitigation may depend on contractual, statutory issues, financial factors or your risk tolerance. Therefore, consult your attorney and your accountant before deciding what insurance protection is necessary to protect your business. It is important that you read the insurance policies and direct any questions to your legal counsel.

For additional information on insurance business topics, you are welcome to visit www.insurancebutler.com or contact Chester Butler at Butler@insurancebutler.com. Chester can also be reached by phone at 1-800-253-1165.