Written by Gene Adams & George J. Pfeiffer of Insurance Service of Asheville (June 2017)
For any business owner—no matter the size of the business—selecting your limits of liability can be a critical decision.
On almost a daily basis, insurance agents enter discussions about liability coverage, including subjects such as Business Autos, General Liability, and Directors and Officers liability, among other types of insurance policies. Typically discussed are injury scenarios (both personal and bodily injury) and the potential lawsuits that result from such.
This inevitably leads to questions about how much insurance one should carry, and what specific “limits of liability insurance” one should have.
Most commercial insurance policies start with a $1-million-dollar limit of liability coverage “per occurrence.” Simply put, this means that one claim (or “occurrence”) could use up to $1 million of the insurance company’s money defending a client and paying any judgments rendered as part of a claim and/or a resulting lawsuit. This basic limit can be increased, of course, at additional premiums, to $2 million, $5 million, or as much as $50 million.
So how does one decide how much liability insurance to carry? What is the thought process? What outside elements enter into the discussion? Does investment/return or risk/reward play in to the equation?
As a starting point, the question that’s frequently asked is, “How much are you going to get sued for?” This is a pretty open-ended question, and at first might seem a little flippant, but hopefully, if you have a thoughtful agent, it starts a discussion and a process that includes some of the following questions: “What can go wrong with your product or business that can result in physical injury or damage to someone’s property?” “Does your business have heavy-duty vehicles on the road that have the potential to injure multiple people and/or cause a great deal of property damage?” “Does your business involve products that people ingest (think food, food products, etc.)?” “Do you advise other businesses and create plans for them?” “Do you advise individuals and create plans for their lives?” Questions such as these help you assess your business and your risk profile, and guide you in choosing your liability limits.
The point is that the type of business you have has an effect on the “limits of liability insurance” you want to carry. The services that you provide, the equipment that you own or use, and the everyday processes that you perform—all of these factors have a profound effect on what you may want in liability limits.
Often, when I am discussing limits of liability beyond the standard policy limits (remember, most commercial policies start at $1 million per occurrence) with a client, I can see them doing the math in their heads: “More liability coverage equals more premium” is the thought process. This part of the discussion should lead your agent to discuss the fact that twice the limit of liability, say going from a $1 million to a $2 million per occurrence limit, does not create twice the cost. Frequently, it’s only a slight incremental increase to the next level, meaning you receive more protection for a very modest increase in cost. The first level of coverage is the most expensive; the higher levels decrease in per unit cost. This is an “affordability” discussion. What can you afford? Where is the line between coverage and affordability?
After this point, the discussion often becomes much more wide-ranging. Talk with your agent about your assets and what other organizations similar to yours carry for their limits of liability. Anecdotal information is always a part of any good discussion about liability insurance, i.e., what have other businesses run into and what do they see in the marketplace? Have others been sued? Caused damages? Of course, this information should not be presented by actually naming other businesses, but the essence is that there are businesses similar to yours out there.
Risk Vs. Cost
There are times when the limits of liability insurance a business carries are not up to the business at all.
Most businesses enter into contracts with other businesses. There are almost always bank loans and banking relationships. These contracts and banking relationships often come with stipulations that require certain limits of liability, or even requiring other types of insurance coverage that a business owner might not purchase if it were up to them alone.
An example of this is a business I worked with a few years ago. They were in expansion mode and went to a bank for a loan for the needed capital to add product, add space, and increase output. As part of the process, the bank required them to increase their current $1 million in liability coverage to $10 million. In addition, the business was required to buy what’s called key man life insurance on each owner (in which, if someone dies unexpectedly, the beneficiary of the policy is the company itself), and to increase the coverage on buildings and inventory.
This specific example leads to some conclusions. The bank’s risk management department had assessed what was needed for this type of loan, and the bank wanted assurance that its money would be protected in case of a catastrophic event. And to get the capital, the business had to meet these criteria.
The good news? The increased cost for insurance was worth the investment, and as a result, the business was far better insulated from potentially dislocating events than in a situation where the owners simply bought what they thought they needed or wanted to afford.
Another important contract to consider is your lease. It often spells out limits of liability coverage and requires the tenant to carry specific amounts of General Liability coverage. Does your agent ask to see your lease? They should. It carries very important information we need to know to write your insurance coverage correctly. Check your lease to make sure you are carrying the limits of liability coverage it requires. The landlords require this as a part of their efforts to limit their risk and to mitigate their damages for the risk you bring them by being a tenant in their building. The best thing about this is that your insurance policy protects you first.
Having a wide-ranging discussion with your insurance agent, other business advisors, attorneys, and partners with whom you contract, and then analyzing as much data as possible are all important pieces of the puzzle in deciding the limits of liability insurance you should carry.
What’s at Stake
An analysis of proper limits of liability can get very technical in some cases. Depending on the sophistication of the business and its risk management department, it can lead to analyzing historical loss patterns, frequency of losses, and severity of those losses. A look at your risk profile and appetite for risk is also important in any case.
Something that I remind my clients of is that insurance definitely carries a cost. However, if you think insurance is expensive, you should think about the cost of being uninsured or under-insured. A major claim or series of claims can risk the very existence of what you’ve worked hard for over many years. A great program of insurance with proper limits of liability coverage can preserve your income, your assets, the lives and incomes of your employees, and the other businesses that depend on yours for income. The effects can be wide-ranging.
I would add that nonprofit businesses also have a great stake in having proper limits of liability coverage. Your mission is important, and preserving that mission is important to your community, your employees, and especially your clients. Your directors and officers also have a need to be well-protected. They are volunteers, and as such, expose themselves to liability for their decisions and for the nonprofit’s operations.
In summary, having a wide-ranging discussion with your insurance agent, other business advisors, attorneys, and partners with whom you contract, and then analyzing as much data as possible are all important pieces of the puzzle in deciding the limits of liability insurance you should carry.
Perhaps the most important thing, though, is considering what helps you sleep at night—knowing that you have done the best that you can to protect your business and your assets so that they are preserved far into the future while preventing catastrophic dislocation.
That is Important with a Capital “I.”
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