When you start a business, you must decide

Starting and Running a Small Business:

Insuring Your Business

A well-designed insurance program can protect your business from many types of perils. Consider the following:

• A fire destroys all the furniture, fixtures and equipment in your restaurant.

• Burglars steal $75,000 worth of computer equipment you use in your book publishing business.

• A customer visiting your yogurt store slips on the just-washed floor and shatters her elbow.

• On the way to an office supply store to pick up some fax paper, one of your employees runs a stop sign and injures a child.

• A house painter has a severe allergic reaction to a solvent that your company manufactures and distributes.

• One of your employees is hospitalized for four weeks with a severe back injury she received while trying to lift a heavy package.

• The building where you’re located is severely damaged by a windstorm. You’re forced to close your doors for two months while repairs are made. In addition to having to pay $35,000 for continuing business expenses, you lose the $25,000 of profits you expected for that period—a total loss of $60,000.

• A client installs a lawn sprinkling system based on specifications you recommended as a landscape architect. Because you hadn’t checked soil conditions carefully, the system malfunctions, flooding your client’s basement and ruining the antique furniture stored there. Your
client sues you for professional negligence.

Maybe none of these will happen to your business—but unless you consider yourself permanently exempt from Murphy’s Law (“What Can Go Wrong Will Go Wrong”), don’t bet on it. Fortunately, insurance is available to cover each of these events and for many, if not most of them, is reasonably cost-effective.

Not every small business needs every type of coverage. In fact, a business that tried to buy insurance to cover all insurable risks probably wouldn’t have money left over to do anything else. Deciding on insurance coverage usually involves some difficult choices. Here are some general rules to start with:

• Get enough property and liability coverage to protect yourself from common claims. These are the most important kinds of insurance for a small business.

• Buy insurance against serious risks where the insurance is reasonably priced.

• Keep costs down by selecting high deductibles.

• Self-insure if insurance is prohibitively expensive or the particular risk is highly unlikely.

• Adopt aggressive policies to reduce the likelihood of insurance claims, particularly in areas where you’re self-insured.

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A. Property Coverage

In considering property coverage, there are four main issues to think about:

• What business property should you insure?

• What perils will the property be insured against? In other words, under what conditions will you be entitled to receive payment from the insurance company?

• What dollar amount of insurance should you carry? (Obviously, the higher the amount, the higher the premiums. You don’t want to waste money on insurance but you do want to carry enough so that a loss wouldn’t jeopardize your business.)

• Should you buy coverage for replacement cost or for the present value of the property?

1. Property Covered

Your insurance policy will contain a section called Building and Personal Property Coverage Form, which lists exactly what property is covered. If you own the building you’re occupying, be sure the building is covered, including:

• completed additions

• permanently installed fixtures, machinery and equipment

• outdoor fixtures (such as pole lights)

• property used to maintain or service the building (such as fire extinguishing equipment).

The policy may also cover additions under construction as well as materials, equipment, supplies and temporary structures on or within 100 feet of the main building.

Be sure that your business personal property is also covered. A typical policy covers the following items located on the business premises:

• furniture and fixtures

• machinery and equipment

• inventory

• all other personal property used in the business (such as technical books and cassette tapes)

• leased personal property, if you’re contractually obligated to insure it

• personal property of others that’s in your custody.

Be sure that everything is covered. Check carefully to be sure the policy covers all the types of personal property that you own or expect to own: furniture, equipment, goods that you sell, products that you manufacture and raw materials used in the manufacturing process.

Typically, various items are excluded, such as accounting records, currency, deeds and vehicles held for sale. If you need coverage on excluded items, you can usually arrange it, for an additional premium.

2. Perils Covered

More than 90% of the time, property insurance for small businesses is written in one of three forms: Basic Form, Broad Form and Special Form. Special Form coverage is the most common and affords the best protection.

Whichever policy you decide on, read it carefully before you pay for it—not just when you’ve suffered a loss. You may discover that some coverage is narrower than it first seemed. For example, smoke loss may refer only to loss caused by a faulty heating or cooking unit; it may not cover smoke damage from industrial equipment. Similarly, an explosion may not include a burst steam boiler. Fortunately, most insurance policies today are written in plain English so you should have little problem in understanding what’s covered and what isn’t. If you need coverage not provided in the policy, talk to your agent about how to add it on.

Basic Form coverage includes losses caused by fire, lightning, explosion, windstorm or hail, smoke, aircraft or vehicles (but not loss or damage caused by vehicles you own or operate in the course of your business), riot, vandalism, sprinkler leaks, sinkholes and volcanoes. The policy defines these perils—and also lists some exclusions, such as nuclear hazards, power failures or mud slides.

Broad Form coverage contains everything that’s in the Basic Form and adds protection from a few more perils, including breakage of glass (that is part of a building or structure), falling objects, weight of snow or ice and water damage. Again, these terms are defined in the policy and, again, exclusions are listed.

Special Form policies are constructed differently than Basic and Broad Form policies and offer wider and slightly more expensive coverage. Instead of listing specific perils such as fire and lightning, Special Form policies simply say that your business property is covered against all risks of physical loss unless the policy specifically excludes or limits the loss. This type of policy offers the most protection. For example, it’s a convenient way to insure against loss by theft, which isn’t covered by Basic and Broad Form policies. (Section D2 discusses theft insurance.)

If you need additional coverage. If you’re concerned about property loss caused by perils not covered or, in the case of a Special Form policy, excluded from an insurance policy, you can often get the additional coverage through an endorsement (add-on page) to the policy by paying an additional premium. For example, such coverage is usually available for losses due to earthquakes and floods.

Earthquake and Flood Insurance

Earthquake insurance can be handled through a separate policy or an endorsement to Basic, Broad or Special Form coverage. Deductibles in an earthquake endorsement are typically stated as a percentage—such as 10%—rather than as a dollar amount. This means that the higher your policy limit, the bigger the deductible. As a result, some business people choose a $200,000 policy with a $20,000 deductible rather than a $400,000 policy with a $40,000 deductible. They reason that the deductible on the latter policy is so high they’re unlikely to ever collect anything.

Flood insurance, by contrast, is usually handled through a separate policy called “Difference in Conditions.”

Combining property and liability insurance in one policy. You can purchase property insurance as a stand-alone and buy a separate stand-alone policy for liability coverage, or you can buy a policy that combines both coverages. It’s often—but not always—cheaper to buy a combination policy. Here’s where comparison shopping definitely pays off.

3. Amount of Coverage

Be sure to carry enough insurance on the building to rebuild it. But there’s no need to insure the total value of your real property (the legal term that includes land and buildings), because land doesn’t burn. Especially if you’re in an area where land is very valuable, this is a big consideration.

If you’re in doubt as to how much it would cost you to rebuild, have an appraisal made so you know that your idea of value is realistic. Because the value of the building and other property may increase, it’s wise to get a new appraisal every few years. Your insurance agent should be able to help you do this.

Usually it’s best to insure your property for 100% of its value. If doing this is prohibitively expensive, consider a policy with a higher deductible rather than underinsuring.

Underinsuring to get a reduced premium is a false economy for several reasons. Not only are you not covered if you suffer a total loss, but it may also reduce your ability to recover for a smaller loss. This is because most insurance policies carry a co-insurance clause which states that to recover the full policy amount, you have to carry insurance to cover at least 80% (this percentage may vary) of the property’s replacement cost or actual cash value. If you don’t, you become a co-insurer if there’s a loss, even if it’s less than the policy maximum; the policy will only pay off a percentage of its face value.

Example 1: Fluoro Corporation owns a $100,000 building. If Fluoro carries $80,000 worth of insurance or more, the insurance company will pay Fluoro for the full amount of any loss up to the policy limit. For example, if the loss is $50,000 Fluoro will get the full $50,000. If the loss is $90,000, Fluoro will receive only $80,000, the policy limit.

Example 2: Pluto Associates owns a similar $100,000 building. To get a reduced premium, the partners decide to carry only $40,000 worth of insurance. If there’s a fire and Pluto has a loss of $20,000, its insurance company will pay only $10,000. Because Pluto carried only half of the 80% figure mentioned in the policy, it’s entitled to only a proportional payment.

4. Replacement Cost vs. Current Value

Historically, in case of a loss, a basic fire insurance contract covered the actual current value of the property, not its full replacement value. Today, policies are routinely available with replacement cost coverage. This is the coverage you want.

Example: Sure-Lock Corporation owns a 20-year-old building. The current cash value of the building (the amount someone would pay to buy it) is $150,000. But if the building burned down, Sure-Lock would have to pay $200,000 to replace it. If Sure-Lock buys insurance based on the building’s cash value and the policy has an 80% co-insurance clause, the company will need to insure the building for $120,000. If Sure-Lock buys insurance based on replacement cost, it will need to insure for $160,000, which is 80% of $200,000.

The real cost of insurance is reduced when you consider that insurance premiums for a business are a recognized business expense—which means they are tax-deductible.

5. Ordinance or Law Coverage

If you’re purchasing insurance for an older building—either because you own it or your lease requires it—understand that a normal Basic Form, Broad Form or Special Form policy designed to replace your existing building should it be destroyed probably won’t be adequate. The problem is that legal requirements adopted since the building was constructed will normally require that a stronger, safer, more fire resistant building be constructed. Doing this can cost far more than simply replacing the old building. To cope with this possibility, you want a policy that will not only replace the building but pay for all legally required upgrades. This coverage is called “Ordinance or Law Coverage.”

Example: Time Warp Inc., sells antique furniture and building materials removed from old homes. In keeping with its image of days gone by, Time Warp does business in a 100-year-old building in a historic part of town. Time Warp carries insurance for the full replacement cost, $100,000. One day a fire destroys 50% of the building. The insurance pays $50,000 toward reconstruction, but the Time Warp owners learn to their dismay that rebuilding will cost much more and that the additional costs are not covered by their insurance policy. The items excluded by their typical property insurance policy include the following:

• The cost of meeting current health and safety codes. The old building was of wood frame construction and lacked an elevator and sprinkler system. That was OK before the fire. The building pre-dated the health and safety ordinances and was “grandfathered”—specifically exempted from the new construction requirements. After the fire, it’s a whole new ball game. In rebuilding, Time Warp must spend an additional $100,000 for masonry construction, an elevator and a sprinkler system required by current health and safety codes.

• The cost of rebuilding the undamaged portion of the building. The local ordinance requires that if a building built before current codes is destroyed by fire to the extent of 50% or more, the entire building must be replaced. The cost of replacing the undamaged 50% of the building is another $200,000.

• The cost of demolition. The local ordinance requires that, because of the extent of damage, the entire building—both the damaged and undamaged portions—must be torn down before reconstruction begins. That will cost another $25,000.

“Ordinance or Law Coverage” would pay for all of these items.

6. Tenant’s Insurance

If you’re a tenant, read the insurance portion of your lease. You may have agreed to insure the building and protect the landlord against any liability suits based on your activities, in which case you’ll need the type of coverage an owner would carry. This is available through a renter’s commercial package policy, which also provides routine product liability coverage for businesses not involved in hazardous activities and allows you to name your landlord as an additional insured.

Even if you haven’t agreed to provide insurance coverage in your lease, a renter’s commercial policy can make excellent sense. Not only will it cover any of your “leasehold improvements,” such as paneling and partitions, but it will also cover damage to the premises caused by your negligence. For example, if the building you rent suffers fire or water damage as a result of an employee’s negligence (a fire in an area where food is prepared spreads and damages the walls and ceiling), you may be liable. This is true even if the building owner is insured and recovers from his or her insurance company, because the owner’s insurer has the right to try to recover.

What the insurer will pay you for loss to leasehold improvements is based not on replacement value but on what’s called the “use interest” in the improvements. Basically, the insurance company looks at how long you would have had the use of the improvements and reimburses you for the use you lose.

Example: Court Reporting Associates (CRA) installs $20,000 worth of paneling in their rented offices. They have a five-year lease with an option to renew for five more years—which, for insurance purposes, is treated as a ten-year lease. Two years into the lease, a fire destroys the paneling. Because CRA used up 20% of the lease before the fire, it will receive payment for only 80% of value of the paneling.

Insurance clauses in leases vary widely.

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B. Liability Insurance

The second major category of insurance coverage for a small business is liability insurance. Your business can be legally liable to people injured and for property damaged because you or your employees didn’t use reasonable care. For example, if a customer falls on a slippery floor and then sues you, you may be liable because you negligently failed to provide safe premises.

As you probably know, when it comes to personal injuries, judges are broadening the scope of what people can sue for—and juries are increasingly generous in awarding damages. Because an injured person can collect not only for lost wages and medical bills but also for such intangibles as pain, suffering and mental anguish, a single personal injury verdict against your business has the potential to wipe it out. For that reason, unless you have a very unusual business that has no personal contact with customers, suppliers or anyone else, your insurance program should include liability coverage.

Some intentional acts not involving bodily injuries are also usually covered under the liability portions of an insurance policy. Examples are libel, slander, defamation, false imprisonment and false arrest.

Toxic Waste Clean-Up

Suppose the government orders your company to clean up a toxic waste problem on your property. This can and does regularly occur even if the pollution occurred years before you bought the property. Will your liability insurance policy cover the clean-up costs (called the “response costs”)? Most courts that have considered this question ruled that response costs are covered by a liability insurance policy, but a significant minority have ruled otherwise. If you have a business or own property that by any stretch of the imagination could become involved in a toxic waste or pollution problem, try to find out exactly how far your liability coverage extends in environmental situations. You may need to buy supplementary coverage (if available and affordable) to cover this risk.

Keep yourself informed on this subject. It’s likely that faced with court decisions saying that general liability coverage requires insurance companies to pay for response costs under clean-up orders, insurance companies will tighten up their policy language to exclude these expenses. You may need to buy special coverage if your business faces the possibility of a clean-up order.

1. General Liability Policies

Liability policies are designed to protect you against lawsuit judgments up to the amount of the policy limit plus the cost of defending the lawsuit. They provide coverage for a host of common perils, including customers and guests falling and getting mangled by your front door or otherwise being injured. Liability policies usually state a dollar limit per occurrence and an aggregate dollar limit for the policy year. For example, your policy may say that it will pay $500,000 per occurrence for personal injury or a total of $1 million in any one policy year.

Excluded claims. Punitive damages—damages intended to punish your business for willful or malicious behavior rather than compensate the injured person—are not covered by the typical general liability policy. And liability coverage won’t protect your business if an employee intentionally assaults a customer. In addition, a general liability policy doesn’t cover injuries caused by defective products or motor vehicles, or by an employer’s liability for injuries received by workers on the job. Special coverage for these types of liability is discussed in the next three subsections.

As noted, both building owners and tenants may purchase liability coverage separately or as part of a package policy that also provides a number of other types of insurance, including fire insurance for the building itself.

2. Product Liability Insurance

Product liability insurance covers liability for injuries caused by products you design, manufacture or sell. You may be liable to a person injured by a defective product or one that came without adequate instructions or warnings. Product liability insurance can be very expensive, but if your business manufactures, distributes or sells a product that may injure people, you should seriously consider it. For example, if you manufacture medical instruments or chemicals, you’ll definitely want to consider buying this coverage. If you’re a retailer and sell products in their original packages and provide no product assembly or service or advice, your exposure is drastically reduced; the manufacturer is primarily liable and the product liability coverage provided by standard renter’s commercial policies should be adequate.

The amount of product liability insurance that you need depends on the nature of your product and not on your gross sales. Obviously, a company that sells $2 million of paper clips a year will need less coverage than a firm that manufactures gauges critical to the safe operation of heaters and also has $2 million worth of sales annually.

3. Vehicle Insurance

Make sure your business carries liability insurance not only on its own cars and trucks but also on employees’ cars and trucks when those vehicles are used for business purposes. This coverage is known as Employer’s Non-Owned Automobile Liability and is relatively inexpensive—a premium of $65 to $100 may buy you coverage of $1 million for one year. Vehicle insurance isn’t provided under general liability policies.

It wouldn’t hurt to check your employees’ driving records before you entrust company vehicles to them or send them on business errands using their own cars, but failure to check won’t be a problem under most vehicle policies unless the insurance company has listed that employee as an excluded driver. To do this, insurance companies periodically ask businesses for the names of employees who are driving on company business. They then check the names against state driving records. If this results in the discovery of a poor driving record for a particular employee, the insurer will likely exclude that driver from coverage and notify you.

Coverage for injury or property damage while using leased vehicles can be added to either your motor vehicle policy or your general liability policy—which is what a company would do if it owned no vehicles. This is known as Hired Vehicle coverage.

Most vehicle policies also cover physical damage to the car or truck caused by collision, fire or theft.

4. Workers’ Compensation Insurance

As the name implies, workers’ compensation insurance covers your liability for injuries received by employees on the job. All businesses with employees are required to provide for some kind of workers’ compensation coverage.

Usually, an injured worker can’t sue your business for negligence. But as a trade-off, he or she can collect specified benefits from your business for work-related injuries whether or not the business was negligent. All the worker must prove is that the injury came about in the course of employment—a concept that has a very broad definition in many states. For example, an employee injured at a company picnic may have a valid workers’ compensation claim.

The amount of money that the employee can recover is limited. The worker can recover for medical treatment and lost wages and, in serious cases, for impaired future earning capacity. But there are no awards for pain and suffering or mental anguish. A growing portion of workers’ compensation claims, however, result from mental or emotional stress. In California, an employee who proves that as little as 10% of his or her disability was caused by job-related stress can qualify for worker’s compensation benefits.

As a sole proprietor, you usually can’t be personally covered by workers’ compensation insurance for any work-related injuries you sustain; only your employees can be covered. Workers’ comp coverage of a partner or of an officer of a small corporation usually isn’t required but can be obtained if you choose.

Each state has a law setting out what an employer must do to provide for workers’ compensation benefits. Sometimes an employer can self-insure. Usually, that isn’t practical for small businesses because they can’t afford the type of cash reserve required by state law. Most small businesses buy insurance through a state fund or from a private insurance carrier. Insurance rates are based on the industry and occupation, as well as the size of the payroll. Your business’s safety record can also influence the rate; if you have more accidents than are usually anticipated, your rate is likely to be increased.

Although workers’ compensation laws cover virtually all injury claims by an employee against an employer, in a few instances employees can still sue an employer for pain and suffering resulting from a work-related injury. For example, in some states, an employer whose gross negligence or intentional conduct caused an injury can be sued. A second part of a workers’ compensation policy (sometimes called Coverage B or employer’s liability) insures the employer against liability for these types of claims. I recommend policy limits of $500,000 for most businesses for this coverage.

Workers’ compensation insurance is required only for employees—not for independent contractors. Small businesses sometimes buy services from independent contractors to save money on workers’ compensation insurance, as well as taxes and other expenses normally associated with employees. That’s fine as long as you correctly label people as independent contractors rather than employees. But if you make a mistake, and a person improperly labeled as an independent contractor is injured while doing work for your business, you may have to pay large sums to cover medical bills and lost wages which should have been covered by workers’ compensation insurance.

In addition, you can sometimes have a problem with a properly classified independent contractor who hires employees to perform some work for you. If you hire an independent contractor who has employees, insist on seeing a certificate of insurance establishing that the employees are covered by workers’ compensation insurance.

Example: You hire Sharon, who is doing business as Superior Painters, to paint your store. Sharon will be doing the work along with two of her employees. If Sharon doesn’t carry workers’ compensation insurance for her employees, and any of them are injured on the job, they may be treated as your employees, which would increase your own workers’ compensation premiums. Also, have Sharon show you that she has general liability coverage; if she or one of her employees injures one of your customers while painting your store, such injuries may not be covered by your own insurance.

For comprehensive guidance on workers’ compensation insurance, see Workers’ Comp for Employers—Taking Control; How to Cut Claims, Reduce Premiums and Stay Out of Trouble, by James Walsh (Merritt Publishing).

The Expanding Boundaries of Workers’ Comp

Premiums for workers’ compensation insurance are on the rise—partly because judges are extending the types of claims for which workers can receive payment. A key factor in many cases is stressful working conditions. Money has been awarded to:

• A worker who suffered a heart attack after an argument with his boss.

• A truck driver who blacked out while driving and was then unable to drive because of anxiety that he might black out again.

• A worker who fainted, fell and suffered a head injury after his supervisor told him he would be transferred to a new department and had to take a pay cut.

Judges have also expanded the right to receive workers’ comp in other situations. For example, benefits were awarded to the family of a convenience store clerk who died after getting into a fist fight with a disorderly customer. And a woman who bought a cold tablet from her employer received payments when the tablet caused her to have tremors due to a congenital condition.

In another case, a cocktail waitress at a resort was on her way home when she stopped to help a resort guest who was having car trouble. The guest sexually assaulted her. The waitress was awarded workers’ comp for injuries she received in the assault. The court’s reasoning: The waitress had been told to be “very cordial and nice to guests.” Therefore, her offer of assistance on the road was related to her employment.

Excerpted from the “Legal Guide for Starting and Running a Small Business”, by Fred S. Steingold