Part III: Insurance and Risk Management

This topic will not address health insurance and will not going into details for specific types of risk but will help you understand the place for insurance in your business, how to manage the process, and how to ask the right questions to get what you need.

Managing risk is something you do from Day 1 (in fact, from Day -120) all the way through to your last day in that business (and sometimes even beyond).  The concept of insurance has existed for more than 3700 years (believe it or not), but really came into being as an industry when the merchant trades arose in the Middle Ages.  It has been a necessity for trade and other commerce since that time, since traders often encountered bad weather that would sink ships, thieves that would steal, and other conditions that would lead to a loss.   There are many parts to mitigating/reducing risk that we’ll talk about in Part IV of this series, but insurance is definitely one of the key (and sometimes most ignored) parts of that strategy.

Today, the insurance industry can cover just about any situation you can imagine.  If your business depends on you having a great singing voice, you can insure your vocal chords.  If you live in an area prone to floods, there is flood insurance.   Keep in mind that insurance is a business as well and is based on the premise that over a large number of people, all of which, are paying premiums, only a percentage will make claims, and even a smaller percentage of those will make large/substantial claims.   Insurance companies (similar to how a bank works with loans) can then take the money from claims they do not need to pay out on and invest those funds to earn additional money (and therefore hedge their risk).  They also hedge (or protect against) risk by diversifying the pool of potential claimants.  Rather than insuring everyone in an earthquake zone against earthquakes, they will increase that pool to include others that are in lower risk areas and by offering other types of insurance besides just earthquake damage insurance, again, in order to hedge their risk.

For a business, there are several types of insurance that are key.  General liability insurance is the most widely used type of policy to cover a wide variety of risks.  The key thing about any insurance policy is getting a clear understanding of what the insurance company states they will cover (the “Coverages”) and what they will not (the “Exclusions”).   It is a lot of fine print, and sometimes, you do need an attorney to help you decipher what it’s actually saying but don’t omit the crucial step of understanding these two elements.

The other types of more specific insurance will depend on what type of business you’re in, what you own (or rent) and where you’re located.  If you are renting, definitely consider some type of renter’s insurance (or specific property insurance, for example, for a storage unit). If you live in a flood zone, get flood insurance (yes, it’s expensive, but so is your property if you need to replace it). If you are in the business of giving advice to others, consider errors and omissions insurance.  If you run a corporation and have directors, consider Directors and Officers’ Insurance.

One really beneficial part of insurance is that, once you have a valid claim, the insurance company has a duty to defend you (that is, provide an attorney) for claims that originate from a lawsuit.   That can be extremely helpful since attorney fees alone could be 3-4x your annual premiums.

Insurance can be obtained either through an agent (someone who works for one insurance company specifically) or a broker (someone that is able to place policies with different insurers).  Each option has its benefits and downsides.   If you’ve been working with an agent who has provided you good results and your happy with that insurance company, stick with it (although price shopping every now and then can’t hurt).

Of course, insurance is one of those costs we discussed early on that does not fluctuate (is not variable) according to the number of items you produce or the number of clients etc.  It is a fixed cost (or overhead) that you then allocate (either as a percentage or specific amount to your pricing/fees.

One last thing to be noted.  Don’t exaggerate, fabricate, or omit things in the application process for insurance.  If you’re found to have deceived the insurance company during the application process, it becomes a basis for them to deny coverage and that’s not something you want to find out at the moment you need to make a claim.  It’s also another reason to create accurate projections.  Most policies will have a relationship to your income of your business. If you mess up your projections, you may end up paying a big premium to match the ego when you created the bad projections.   Again though, unreasonably (and substantially) underestimating on purpose will get you a denial of coverage later on and that’s not a good result.