Small Business Insurance: Starting from Scratch:
Small business owners have a lot on their plate, and their priorities are often a frantic jumble of product, suppliers, staff, clients and marketing. Amidst the madness, they also need to wrap their head around the risks their business faces and what kind of insurance can help them mitigate those risks.
Today we’ll look at some of the major considerations for first time business insurance clients, with the aim of giving the people who run small businesses a head start in understanding and purchasing their coverage.
The first step to understanding insurance is to assess the risks your business faces. You’ll want to divide them into two camps; the ones that are insurable and the ones that aren’t.
Your business will face a bunch of risks that it can’t insure against, such as increased competition, declining margins, staff turnover, or the failure of a new product to make a splash in the market. These are risks that you’ll certainly want to try and avoid or mitigate, but you won’t be able to negate them with insurance.
On the other hand, you can insure yourself against lawsuits with General Liability and Errors & Omissions insurance. And you can protect the value of a building and contents as part of a Business Owners Policy (BOP). The things you can insure against are the ones we focus on.
Before you start looking at insurance itself, however, take a minute to ask yourself to how you feel about risk. Are you risk averse, or a bit of a risk seeker? Most people lean towards caution and prefer less volatility in their outcomes, but some like taking a chance. Ask yourself how much risk you can stomach (risk tolerance), how much you can afford (risk capacity), and how much you really need (risk required). These questions will paint a picture of your attitude to risk, and play a central role in the way you approach and eventually structure your insurance plan.
Your risk assessment will also have a central theme that you’ll need to keep in mind – severity and probability. The key concept is that severity is king, because the impact of an event is way more important than the likelihood of it occurring. For example, if your actions could result in the death of a client, this is a huge risk despite the chances of it occurring being remote. The possibility of your laptop being stolen might be greater, but the event will have far less impact. Severity always trumps probability.
THE LAY OF THE LAND
An understanding of the insurance framework will help you make smart insurance decisions. To facilitate this understanding, let’s cover off a few common questions:
Why do I need insurance anyway?
Primarily, to guard against loss. Insurance effectively transfers risk from your business to the insurer in exchange for a fee (i.e. the premium). You pay a little to avoid losing a lot, and to provide more certainty in the scope of outcomes your business faces.
You may also need to buy insurance to tick regulatory or compliance boxes. Landlords often want tenants to have General Liability policies in place, and many professional associations have minimum insurance standards for members.
There are a slew of other advantages; having a solid insurance policy will often give credibility to your organisation and put you in a position of strength to negotiate with both partners and clients.
What Are The Main Insurance Types?
This is far from an exhaustive list, but the four main areas of business insurance are:
- General Liability insurance is designed to protect your business against lawsuits for injury or property damage, and sometimes also includes Product Liability to cover damage caused by products you manufacture or sell.
- Professional Liability Insurance (Errors & Omissions)protects your business against claims of negligence, mistake or representation. If you’re a professional whose business operates by providing a service or advice, this should be a critical consideration.
- Business Owners Policy is a flexible package that combines General Liability insurance with a host of other coverage options, including Building, Contents, Business Interruption, and more.
- Workers Compensationis a policy that provides coverage for your employees who are injured on the job.
How Much Cover Do I Need?
Whilst there’s no magic formula, there are a few considerations for assessing how much cover you’ll need. Each business has a unique profile, but the items below should generally come under consideration when trying to figure out the level of cover required:
- Stock Levels
- Equipment Value
- Property Value Turnover
- Business Size
- Leasing & Contract Requirements
- Regulatory & Association Requirements
- Leased & Hired vehicles
A lot of the considerations above will guide your thinking when it comes to assessing options in a Business Insurance Policy (BOP) such as Contents and Equipment cover, Business Interruption and Non-Owned Auto.
General Liability is a type of legal liability, and the premiums are coverage amounts are generally high because of the potential for huge claims that encompass legal fees and compensation costs. Coverage of $2 million is common, but $5 million is not unheard of.
In the same way, Professional Liability (or Errors & Omissions) insurance is usually for a large amount as claims of negligence, mistake or representation can be incredibly expensive. Again, coverage amounts range up to and above $1 million.
How Can I Save Money?
- Insure the major loss exposures first
- Select as high an excess as you can afford
- Don’t duplicate your insurances
- Buy a package policy (BOP)
- Avoid making any minor claims
- Periodically review your coverage
Can I Get Away With Under-Insuring?
You sure can – until you need to make a claim!
If you insured a $10,000,000 building for $5,000,000 and it burnt to the ground you’d be looking at a $5,000,000 shortfall, so a full claim would probably place your business under financial stress.
Most insurers also have an under-insurance clause for partial claims, which are paid on a pro-rata basis. So if we have the same scenario as above, except only $5,000,000 worth of damage was incurred, you’d only get paid out the percentage insured amount, which would be 50% or $2,500,000.
OTHER TIPS AND TRAPS
- Read your Insurance Policy Document. These documents are much more user friendly than they used to be and contain important information about your policy.
- Be honest. You are obliged tell your insurer about everything relevant to your insurance. Lying or omitting information can adversely affect your chances of a successful claim.
- Check Exclusions. If a policy is exceptionally cheap, it may be because some of the likely claim scenarios are excluded. Again, check your Policy Document or ask your broker.
- Sub-Limits.Another thing to watch out for; specific events in your cover may have smaller coverage amounts that you’ll want to be aware of.
When it comes to business insurance, you don’t need to insure everything under the sun. Take care of the important stuff first, the risks that have the potential to financially cripple your business. Then account for the particular risks that your business faces, and judiciously select the coverage you feel comfortable with and can afford. It may cost a little money, but business insurance will stop your worst day as a business owner from being your last day as a business owner.
Daniel Scott joined BizCover in 2015 and is the Head of BizInsure, BizCover’s US operation. Prior to Bizinsure, Daniel worked as an insurance industry consultant, investment banker and portfolio company CEO. Daniel holds a MS from Stanford University and is a CFA charter holder.