Insurance wise or insurance poor?

What insurance and how much insurance does your business need?

Perhaps your first experience with insurance was something like mine. When I was in the fourth grade my parents decided to officially put me on the payroll at the family store. While I had been working before then, I was given something in the store I wanted, or simply some cash.

The check looked neat and it felt like being a grown up as I walked down the street to open my first checking and savings accounts. As a child I was nowhere near as interested in numbers as I am today, but at some point I did figure out the hourly wage my parents were paying me and the number of hours I worked in a week, did not multiply to become the dollar amount in the paycheck. Somehow, the paycheck was always less. And with that math test, I found there was something called FICA.

“Dad, what is this FICA and why is it getting my paycheck?”, was the question.

FICA turned out to be Federal Insurance Contributors Act, and also my first experience with the word, “insurance”.

As we age, we likely had an experience with the first car or truck we owned and the need to have insurance. The state or province you live in has requirements for a minimum level of insurance and if you are making payments to a lender on that vehicle, they also have requirements.

When you purchased your first residence, if you have a mortgage you would have a requirement from the lender that you have mortgage insurance. And when you were first on your own, you likely found a need for health insurance and perhaps vision and dental insurance. For those younger individuals, your first experience with health insurance may have come with the Affordable Health Care Act, often called Obamacare.

If that was not enough, if you married you were likely told of the need for some form of life insurance to provide for your spouse, and perhaps children, in the event something happened to you and you were no longer able to provide an income for them.

Then you decided to own your own business. Insurance needs took on a whole new meaning when you bought or opened your business. Just as all the insurances mentioned for your personal needs need to be thoroughly researched, the same and more could be said for your business insurance.

Some of the insurances that businesses have are required like the personal insurances we have described. Others you will have to decide if you are being “insurance wise” because you make the right choices, or “insurance poor” because you have so much coverage and the premiums cause your operating expenses to be out of line.

So, what do you insure? Why do you insure? And how much insurance do you buy?    
        
Let’s start with asking what your legal business entity is. While we will cover this topic in depth in a future article, you need to know if there is a legal issue with your business, what is your personal responsibility. As a quick example, if you are a sole proprietorship or partnership, most likely if there is a judgement against your business (think someone getting hurt in your business) a judgement against your business can leave you with the liability.

When your business is a C corporation or S corporation, as a stockholder, you may not be liable for judgements against the business. With some of the other four business entity formats, you may need to have insurance that also covers your personal assets as a judgement could pass through the business to you as an individual.
These are not offered as legal opinions, but in making decisions about insurance, you do need to know what and why you are buying insurance.

Deciding what we are going to insure, we would first look at the three biggest assets your business has. Oddly enough, only two will appear on the balance sheet.

For most businesses the biggest asset they have is their inventory. Businesses that own their own building often find the building itself is their biggest asset. And the big asset that does not appear on the balance sheet is you as the owner or major stockholder.

The inventory; several bad things can happen to your inventory. There can be a fire. Even if the fabrics are not burnt, the smoke damage from a fire next door can render the fabrics worthless. Water from the sprinkler system or a fireman’s hose produces the same results. If your store is in a low lying area, there could be a flood. There could be theft; internally or externally.

With each situation we described, your business loses part or all of what is likely your biggest asset. While this may seem as a clear-cut situation of what you insure and how much insurance to buy, it is not quite that simple.

The first consideration is what is called the “deductible”. The deductible defines how much of a loss you have to pay for before the insurance policy begins to pay.

If you have a $5,000 deductible and there is a $6,000 loss, you are responsible for the first $5,000 and the insurance company will begin to pay after that amount meaning they will pay you $1,000.

When you select a lower deductible, the premium for your insurance policy increases. You have to decide how much of the loss your business can afford to cover. The deductible scenario happens in many of the aspects of the insurance you purchase.

Your building insurance is subject to the same deductible scenario. There are several additional considerations. Is your business in an area that could be subject to a hurricane, flooding or earthquake? Situations like these frequently require your purchasing a “rider” to cover any of these losses. These losses may also be subject to different deductibles than the rest of the policy for your building.

With both the inventory and building, you need to pay careful attention to how much coverage you are purchasing and the value of the inventory or building. When the amount of coverage purchased is less than the actual value, you may find yourself in a situation called, “co-insurance”.

As an example, a store has $100,000 in inventory and in the insurance policy you have bought $50,000 in coverage. If this store had a total loss of inventory, the insurance company is only going to pay for $50,000 in loss.

One caveat in inventory insurance. Many policies state a seasonal fluctuation allowance. The means the insurance company recognizes you are a retailer and the amount of inventory in your business fluctuates from month to month.

As an example, a policy that has coverage of $100,000 and a 20% seasonality fluctuation allowance means you can have inventory of as much as $120,000 which would be covered in a loss. You need to make sure your policy has this coverage, the amount of fluctuation and how many months you can fluctuate above the inventory coverage amount.

The third most important asset in the business is you. Is there insurance on you? This type of insurance is frequently referred to as “key person” insurance. It can be a form of life or disability insurance. In the event you are unable to do your job, or that you die, the insurance policy pays.

If the business ownership is a partnership, both owners may have a policy which will provide the business with dollars to find an individual to perform your duties. A business that has a loan may find the lender requires a key person insurance policy on you to cover the expense of a person to operate the business in the event of your incapacity or death.

After the big three assets, there are several other areas of insurance to be aware of. One area that many people first think of is liability insurance.

As an example, a customer is injured while in your store or injured while using a product they purchased from your business. Watch television during the day and you will likely see more personal injury attorney advertisements than any other type of ad.

Even if you know the claim against you is false, many businesses have found their insurance company will settle the claim as compared to letting the lawsuit go to court. The amount of coverage you should purchase begins with a conversation between you, your attorney, and your accountant.

Unfortunately, in talking to your insurance agent too many agents answer the question of how much insurance with an incorrect, “As much as you can afford”.

Then we have the issue of your employees. What happens when your employee is a thief? The employee is injured in the business? What happens when you fire an employee? Oddly enough with these three situations, your coverage lies in three different insurances.

The theft situation is one in which you want to make sure the inventory insurance we first discussed also includes losses of other forms such as stealing cash or their selling a $15,000 machine to a friend for $100.

The employee injury issue is why you frequently see the question of, “Were you injured on the job?” on an initial medical report. While this is frequently a legitimate situation, those attorney advertisements on television and on billboards frequently ask if you were injured on the job. This situation and outcome can be similar to the previous one in which we mentioned an attorney.

Yet another area of insurance coverage to be considered is that which covers the situation when something causes your business to be closed temporarily or sustain a loss of business. There are many scenarios that would cause this situation to occur; fire, flooding, etc. You first need to know what catastrophic situations are covered. The second bit of information you want to know is how long the coverage lasts. And third is what expenses, and possibly profit, is covered.

Having two friends, each of which had their business burn, they find themselves suddenly with multiple expenses that do not stop while income, and profit, have ceased.

You will find many choices in selecting a “business continuance” policy. Will it cover your operating expenses (including your paycheck)? Will it cover the profit your business would expect to make while being closed? What about your employees? If your business is closed while you rebuild, what happens with your employees? A component of business continuance insurance can provide paychecks for them as well.

The last component of insurance we will cover is health and life insurance for employees. Health insurance, including vision and dental care, can come in many variations. The Affordable Care Act, previously discussed, is one you will likely want to talk with an individual qualified in healthcare.

The life insurance mention comes from another recent experience from a business owner we know. An employee was killed in an automobile accident that was not related to their job.

However, after the death it was found this primary “bread winner” had not purchased any life insurance for the widow and two children. Understandably, it is very difficult for an employer to simply attend the funeral of this long term employee, and just offer condolences to the family.

Just as we often can get a discount with the more we buy, you may find a similar situation in finding a life insurance policy that covers all of your employees.

Our final thoughts on insurance come from other experiences of business owners we know. The individual we mentioned whose business burnt, did not know he had purchased coverage that paid wages to his employees during the 11 months it took to rebuild the store.

Just as you need to know your financials and not completely depend on an accountant, you do not need to leave this to an insurance agent. Speaking of agents, you need to have all of your insurance policies and situation reviewed by a different agent at least every other year.

Even if your insurance agent is one who represents multiple companies, you need to get another agent, in a different company, to look at what you are doing.

With any and all insurances for your business, you and a qualified advisor need to discuss all the possible situations that could happen to your business as well as how much of any loss you can afford to shoulder in an effort to keep your premiums in line with your other business expenses.

All said, you can be insurance wise as well as you can be insurance poor. There is a proper balance to be had.

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