How to distinguish smart coverage from superfluous
This policy wouldn’t pay a ransom; it would replace a kidnapped child with a new kid. There was even an implied social benefit in that, over time, kidnapping children would decline because a criminal wouldn’t want to get stuck with a child that nobody wanted back.
This is a silly concept, of course, even for a tabloid, but the idea behind it is serious: Which insurance products are necessary and appropriate, and which are frivolous?
Understanding the need for basic liability, automobile, property and workers compensation insurance is a given. But understanding blurs when owners consider the countless enhancements to these basic forms. It’s hard to sort through new coverage offerings promising protection if their products don’t work, if their identities are stolen, if employees are wrongfully terminated — even if their employees are kidnapped.
How then, does a business owner have confidence in purchasing the right insurance? Every owner should determine the loss potential for their business. Once identified, potential risks should be professionally evaluated. How likely are they to happen? What is the possible impact on the company? The truth is, insurance is not always the answer to financing risk. Insurance works best when a loss is unlikely but the consequences of a loss are severe.
Consider the company that had several small fires in its plant. This company purchased insurance for those instances in which a fire would have a serious financial impact, but self-insured the small fires they had through a basic deductible.
Here are typical business risks:
• Physical loss by wind, fire or theft.
• Death or disability of the owner
• Physical damage
• Business disruption
• Employee injury
• Liability assumed by contract
• Key employee leaves to work for a competitor
• Bankruptcy of a creditor.
After evaluating the likelihood of financial loss, the next step is to determine how to address these risks. Each loss possibility may have a different solution, depending on the event, the possible financial impact and the likelihood of occurrence. Options include:
Avoid the risk. Some contracts are too onerous; negative implications can be avoided by not getting into the deal.
Modify the risk. Take steps to lessen possible frequency or severity, such as credit checks, keeping credit lines small and requiring prompt payment to lessen the effect of bad debt.
Self insure. Establish a separate account to fund contingency losses.
Transfer the risk. Assign the risk to an insurance company or other business partners.
A combination. Here’s an example: a cable TV company can avoid the potential exposure of home hookups by engaging a subcontractor. Responsibility for possible losses can then be contractually assigned to the subcontractor, along with a requirement for adequate insurance. If the subcontractor happens to sever a gas line, any damage or injury would not affect the cable company, since the loss was assigned to the subcontractor.
Match coverage to risks
Funding risk generally includes the purchase of insurance. The key to an effective insurance program is to match coverages to identified risks. Having a catastrophic mindset and insuring your business for the big event tends to be the most cost-effective approach to purchasing insurance. At this time, the insurance marketplace continues to soften, and competition is heating up. Businesses are taking on larger deductibles and actively managing their own areas of exposure.
The foundation of all business insurance programs is protection that is required to do business. After those are covered, consider these second-tier insurances, again depending on your company’s situation: property in transit; directors and officers liability; machinery and equipment damage; employee dishonesty; fiduciary liability.
A third tier of insurance offers specialty protections where standardized coverages or competitive pricing may not exist. This tier may include product recall, computer security or fraud, product efficacy or reliability, legal reimbursement, patent enforcement abatement, political risk due to governmental action, kidnapping (not person replacement coverage), environmental, and error/omissions exposure.
Again, risks that are transferred to an insurance company are typically low-frequency / high-severity events. The low frequency makes them difficult to predict, but they may be large enough to impact the financial integrity of your business if they occur.
