How to Prevent Your Small Business from Becoming Insurance Poor

During my career I have started several businesses. One of them became an overnight success and grew to be worth over $35 million. Another demanded much more capital to create than I originally thought. I originally budgeted $300,000, and it eventually required a total investment of $3 million before it started to turn a profit.

Small Business Insurance

One of the earliest decisions an entrepreneur needs to make is the type of insurance to purchase and how much. This is a complex question and there really is no “right” answer.

Early on in my insurance career (over forty years ago), I told a man he really didn’t need flood insurance because he was at least fifty feet above the level reached by any past floods. A year later, a downpour sent water from above above his business location, flooding his storeroom. The water never got more than eight inches deep, but it ruined all the paper in his storage area that he had for his printing business.

That taught me a very good lesson about telling people what insurance coverage they don’t need: The minute you state what a person needs Murphy’s Law will prove you wrong.

The Small Business Administration site states, “Insurance coverage is available for every conceivable risk your business might face.”  That’s exactly the kind of claim that makes great fodder for a professional liability loss for an insurance agent, because it simply is not true.

Kennel FireSeveral years ago, a dog kennel burned to the ground. The owner lost about twenty dogs. I was sued as a general agent under the legal theory that I should have taught the retail agent enough about insuring a dog kennel to make sure he had animal mortality coverage on the dogs. That coverage is available through a select number of companies, but is rarely carried by kennel owners because of the cost and restrictive coverage. The court quickly dismissed me from the case. No one buys insurance to protect against a highly improbable loss, but they all wish they had once that one in a billion occurrence happens.

Insurance is only really available if it is affordable. I’ve been a Lloyd’s of London correspondent for over three decades and have delivered quotes for many unique and unusual risks. Many of those quotes seemed ridiculous, even to me, but some were purchased.

The lesson to be earned from my experience with the dog kennel owner is that if you’re starting an insurance agency, an insurance coverage you must have is professional liability (Errors & Omissions Insurance). It is important because it is a primary exposure of the business. Any small business owner should try to determine what their primary exposure is, and then make sure that it’s covered.

Actually, a good rule of thumb for a new business would be to start with the coverage you are required to carry by law. After satisfying your statutory requirements, you should then consider that coverage you’re required to carry by your lease(s) or by mortgagees or lenders.

  • Your coverage options might include:
  • Businessowner’s Policy
  • Commercial Package Policy
  • Professional Liability
  • Comprehensive General Liability
  • Business Income Insurance
  • Commercial Property Insurance
  • Commercial Auto Insurance
  • Crime Insurance
  • Disability Insurance
  • Group Health Insurance
  • Long-Term Care Insurance
  • Surety Bonds
  • Workers Compensation
  • Umbrella/Excess Liability Insurance
  • Flood Insurance
  • Earthquake Insurance
  • Pollution Liability Insurance
  • Director’s and Officer’s Liability Insurance
  • Fire Legal Liability Insurance
  • Data Breach Insurance
  • Inland Marine Insurance

The good news is some of the above are redundant. The bad news is that this list is far from comprehensive. The really bad news is that you can never purchase “enough” insurance. Consider the Texas anhydrous ammonia distribution plant that reportedly had $1 million in liability coverage to cover the estimated $100 million in damage done by their fire and explosion.

In many states it is extremely hard to “pierce the corporate veil”: to hold shareholders responsible for awards beyond the corporate assets. After satisfying statutes and written agreements, what you actually “need” and what you should carry becomes largely personal preference.

Start Your Insurance Program with Workers Compensation

Since workers compensation is a required coverage by statute, it is a good place to start. Your state might allow you to exclude officers of the corporation from coverage, which could save you money.  Be very careful to document that decision.

Next, give your rental-space lease a thorough review to make sure what insurance you’re required to carry. You should review this before signing the lease, to be in a position to negotiate terms.  You probably will be required to carry Fire Legal Liability, which protects the building owner’s interest in the even that you are responsible for starting a fire that damages his property. You most likely will be required to carry general liability insurance and name your landlord as an additional insured.

Copier Insurance

If you lease a copier or other office equipment, that lease will require certain insurance. They will more than likely require a policy to cover the equipment for fire and other perils.

If you have a loan and have pledged assets, you need to meet the requirements in the loan document and provide certificates of insurance to the lending institution.

If you have a company-owned vehicle and have a bank loan, you will need to meet the insurance requirements of the loss payee.

Should you not meet the requirements of a loss payee, or other lender, the lienholder has the right to purchase “forced placed” insurance to cover those requirements and bill you for the premium. Those premiums are normally quite expensive.

Commercial auto insurance is required by statute to carry bodily injury and property damage liability insurance and by your loss payee to carry physical damage coverage. If you have a loss payee, Collision and Other Than Collision coverage are normally both required, in addition to a set limit of liability insurance.

Save Money by Buying an Insurance Package

Insurance companies offer discounts for placing multiple lines of insurance through them. Some insurance companies will even provide a discount on your auto and general liability should you place a life policy through their life subsidiary.

Your insurance agent might recommend a BOP (Businessowner’s Policy) or a Comprehensive Business Policy. The difference is in how many lines of coverage are included. Both of these policies include a range of automatic coverage for such things as general liability, products liability, profit insurance, extra expense insurance, mechanical breakdown, personal injury, valuable papers, accounts receivables restitution, crime, inland marine, and electronic data processing equipment. These polices normally do NOT include flood or earthquake.

Professional Liability Might Be Your Most Important Coverage

For many small business start-ups, a good professional liability coverage is important. This coverage not only covers improperly performed professional tasks, but also covers failure to perform necessary acts. Over the years I have had several of these actions brought against my agency. I sell millions of dollars of annual premiums per year, and with hundreds of thousands of transactions it is almost inevitable I will be sued. The suits have never resulted in a paid loss, but because the coverage includes legal defense, I have saved many thousands of dollars. General liability normally excludes professional acts.

Stand Alone Liability Coverage

There are many kinds of liability coverage that are normally excluded from a General Liability policy. These might include: pollution liability, aircraft liability, liquor liability, watercraft liability, product recall liability, and director’s and officer’s liability, as well as others.

Start-ups might not consider director’s and officer’s liability as essential. If you’re a certain kind of start-up you might find yourself the target of patent trolls. Patent trolls aggressively misuse the patent law as a business strategy. There are director’s and officer’s policies that will respond on your behalf to this kind of attack. In many instances this could be your most important coverage.

Employee Benefits

Health Insurance is important, but is becoming less and less of an issue for small start-ups because individuals can purchase reasonably priced insurance and it is portable.

Your business will have a value right from the start, based on the employees you have put together. A key-man life policy should be considered for those people within your organization that are irreplaceable. A good agent can help you construct a split-dollar Life policy that will allow you to keep good employees through “golden handcuffs” by allowing them to have the cash value if they stay with you a set amount of time (vesting), while your company enjoys the protection of the death benefit.

My business has fluctuated and survived at times because of the loan value of our Life policies. It has been a source of capital during times when credit has been highly volatile.

Dental insurance is an option that I’ve never thought extremely important although it is a large industry and quite popular coverage for some.

Although I’ve carried Disability Insurance for my employees for three decades I think it is an extremely weak coverage that might be one of the last things you can afford. Proving disability appears problematic to me.

I have also carried Long Term Care insurance for my key employees for three decades and believe it has been an important coverage although none of my employees have ever used it.

Limits of Liability

You need to decide what asset level you need to protect and the kind of catastrophic exposure your business represents. In hindsight, having an anhydrous ammonia facility represents a huge risk that should have several million dollars in coverage for liability. On the other hand, a shoe store might not have apparent potential for huge liability losses.

In general, every company should consider an excess liability policy of at least $1 million. This kind of policy is often called an “umbrella” policy, but it is quite rare that excess policies today are true umbrellas because insurance companies want to know what their exposure is for high limit policies. Excess liability policies are normally following form, in that the coverage mirrors the primary policy. A lot of insurance companies are willing to provide $1,000,000 per person and $2,000,000 per occurrence. The cost to purchase larger primary limits is normally relatively small. This is not an area to look to rely on for cost savings. Even a shoe store can have a trip and fall loss that results in paralysis and long-term injuries.

A true umbrella has coverage that is much broader than most primary policies in that it will have fewer exclusions of coverage.

Once you decide what level of liability limits you want, you should logically carry that limit through your various insurance policies. For example, it is illogical to carry much lower limits on auto insurance liability than on your general liability. It is also illogical to carry minimum limits on uninsured and underinsured motorists coverage when you carry higher limits on the liability. About 14% of all vehicles in the United States are uninsured so the potential for loss under uninsured motorist is quite high. A large percentage of insured vehicles carry statutory minimums, which are woefully inadequate in catastrophic claims.

Crime Insurance

In my personal experience, I have been involved in more large-employee dishonesty losses than large fire losses. The circumstances are always tragic and devastating. In one loss that I insured, the bookkeeper of a ready-mix concrete operation took over $400,000 from company that had a net worth of far less than that. In another loss, a deliveryman took over $100,000 from a laundry in increments of less than $35 over a twenty-year period.

The largest employee dishonesty loss I was involved in was in a bank and cost over $2 million. I had another bank loss of over $1.5 million.

Many employers have told me over the years, “Carrying insurance for employee dishonesty would be like telling my employees I don’t trust them.” That isn’t the cast. Rough Notes indicates that the American Management Association estimates 20% of business failures are due to employee dishonesty. The most honest person will succumb to temptation if the circumstances force the issue. People and circumstances change.

One pattern seems to hold true in most employee dishonesty losses. The person is highly trusted, rarely takes a vacation, and handles a portion of the business’ transactions exclusively. It is simply good business to have multiple signatures required on company checks and to rotate duties in sensitive positions.

Other crime coverages that should be considered are: Forgery, Theft of Money and Securities, Theft and Robbery Outside the Premises, Robbery and Safe Burglary, and Computer Fraud.

Computer Privacy Issues

The government can quickly put almost any company out of business with fines related to data breach. This coverage is almost mandatory if you’re handling private data.

In October 2013, a Missouri Federal Court proposed the following settlement of a data breach case for a large supermarket chain that involved 2.4 million customers. It included the following:

  • Pay up to $10.00 to each customers for every card that was compromised and had fraudulent charges posted to it;

  • Pay customers for certain unreimbursed out of pocket expenses such as bank overdrafts and late fees;

  • Pay for up to 3 hours for documented time spent at the rate of $10.00 an hour for customer’s time spent on the data breach;

  • A cap of $1.6 million would exist on all of these customer reimbursement expenses, up to $170.00 per class member.

  • Pay up to $10,000 for each related identity theft loss with the total capped at $300,000;

  • Pay up to $635,000 for plaintiffs’ attorney fees;

  • Pay $500.00 to each of the nine main plaintiffs in the lawsuit.

This chain had data breach insurance and adequate assets.

Surety Bonds

For many businesses, many bonds are a statutory requirement. For many others, they need surety bonds to qualify for contract bids. Court mandated bonds are, of course, a top priority.

Inland Marine

This coverage might be required by your lender. For example, if you own a wind farm, you probably will want inland marine coverage on your wind turbines to protect against physical loss.

Contractors will want inland marine on their equipment and tools because theft of tools is quite common.

Like with all physical damage insurance, you can reduce your insurance bill with higher deductibles, but usually it is hard to justify large deductibles for start-ups.

If you have customers’ goods in your care, custody and control, like a dry cleaners, you will want an inland marine policy to cover that exposure.

I have not covered every possible kind of insurance and may have left out the very coverage your small business needs.

Most insurance agencies either specialize in certain kinds of businesses, or will consult a Coverage Applicable book.

Many insurance companies have helpful guides for their licensed agents to help them work through your needs. My agency works with a number of national carriers that provide excellence assistance on their websites for deciding what coverage is needed. They also have specialty coverage endorsements for specific businesses.

Selecting what is best for you is a tough job. A good agent will show you your alternatives and discuss your options within those alternatives. The agent’s comments will help you make your ultimate decision.

James Holm