Business Insurance

This article focuses on business insurance. It provides an analysis of the different types of business insurance including business owner's insurance policies, business liability insurance, workers' compensation insurance, key employee life insurance, business disability insurance, marine insurance, business interruption insurance, computer insurance, business automobile insurance, and crop insurance. The main uses for business insurance, including deferred compensation funding, buy-sell agreements, and corporate risk management, will be described and analyzed. The issues associated with the use of business insurance as a risk management tool will be addressed.

Keywords Business Automobile Insurance; Business Insurance; Business Interruption Insurance; Buy-Sell Agreements; Captive Insurance; Deferred Compensation; Geopolitical Risk; Insurance; Key Employee Life Insurance; Liability Insurance; Pure Risk; Risk Management; Speculative Risk

Insurance & Risk Management > Business Insurance

Overview

Business insurance refers to insurance coverage purchased to protect against loss exposures and risks for business firms. Business insurance is one of the most common and important corporate risk management strategies used today. Risk management, which refers to the process of evaluating, classifying, and reducing risks to a level acceptable by stakeholders, is common practice in both the public and private sectors. Businesses purchase insurance as a means of transferring the risk away from the business to an outside party. Insurance needs vary between businesses and industries. In the United States, businesses are required by law to have at least three main types of insurance including unemployment insurance, social security, and workers' compensation. Businesses choose supplemental forms of insurance to protect themselves from potential risks. Business insurance is targeted at specific business risks. Business risks include pure risk, speculative risk, operational risks, market risks, cultural risks, economic risks, political risks, and credit risks, equity risk, equity index risk, interest rate risk, currency risk, and commodity risk.

Examples of risk scenarios covered by business insurance include terrorism, fire, death of key employees, customer injuries on the premises of the business, and natural hazards such as earthquakes and hurricanes, procedural errors; internal control failures; failure of information processing equipment; malicious or fraudulent actions by individuals; workplace safety issues; succession failures; unintentional failures to protect clients; damage to physical assets; failures to follow regulations; business disruptions including terrorism and vandalism; computer and network crashes; service or product quality lapses; fraud; failure to comply with regulations or company policies; shifting political landscapes; unanticipated inflation and exchange rate change, decline in customer buying habits, and a shrinking market (Bloom & Galloway, 1999). Business risks vary in their frequency, predictability, and severity of outcomes or losses. Risk mangers choose the risk management tool best suited to manage the risk. Business insurance is one of the main tools to mitigate and transfer risk.

Business insurance protects property, employees, customers, and business operations. Property insurance protects business properties. Unemployment insurance, workman's compensation insurance, health insurance, disability insurance, and key employee insurance protect employee interests. Liability insurance protects both business owners and customers. Business interruption insurance, key employee insurance, surety bonds, employment practices, and liability insurance protect business operations. Businesses choose their insurance based on their financial resources, risk philosophy or risk appetite, business goals and objectives, and perceived risks. Businesses engage in the following steps when choosing their business insurance. First, businesses assess what parts of the business require loss protection. Examples include equipment, inventory, buildings, liability, business interruption, business vehicles, and key employees. Second, businesses decide what level of coverage is required. Examples include total, fire, theft, catastrophe, accidents, and loss of income. Third, businesses decide which people related to your business you would like to insure. Examples include all employees, key employees, or customers. Fourth, businesses choose an insurance agent or broker and purchase one or multiple insurance policies. Ultimately, businesses purchase business insurance based on their needs, liabilities, risks, and resources as well as state and federal laws.

State governments oversee and regulate the business insurance industry. State regulation of business insurance focuses on rate regulation, disclosure, fair play, and compliance. Each state has an office, division, or department of insurance that is responsible for establishing their state rules and regulations by which the insurance industry must abide; that records and helps resolve consumer complaints; conducts insurer examinations; collects fees and administers licensing; and reviews insurance rates and products. State governments began creating separate departments of insurance oversight and regulation during the 1850s and 1860s. The federal government confirmed the power of state governments to regulate business insurance rates in 1945 with the passage of the McCarran-Ferguson Act. The McCarran-Ferguson Act (U.S. Code Title 15, Chapter 20) declares insurance to be interstate commerce and empowers the states to regulate the insurance business (Merkel, 1991).

The following section describes and analyzes the main types of business insurance including business owner's insurance policies, business liability, workers' compensation insurance, key employee life insurance, business disability insurance, marine insurance, business interruption insurance, computer insurance, business automobile insurance, and crop insurance. This section will serve as the foundation for later discussion of the issues associated with the use of business insurance as a risk management tool.

Applications

Types of Business Insurance

Businesses use insurance in three main areas of operations: Deferred compensation funding, buy-sell agreements, and corporate risk management. Deferred compensation refers to an arrangement in which a portion of an employee's income is paid out at a date after which that income is actually earned. Corporations use life insurance to fund deferred compensation arrangements for highly paid executives. In addition, companies use insurance to provide retirement income for employees while managing the tax consequences of the obligation. Insurance as a deferred compensation funding vehicle has cash-value. Cash-value insurance policies have numerous advantages: Tax-advantaged investment appreciation; option to withdraw part of the accrued cash value; and option to borrow against the accumulated cash value. Buy-sell agreements refer to an agreement used by businesses to sell the interests of a deceased owner to the remaining partners at a predetermined price or using a predetermined formula. Buy-sell agreements, also referred to as cross-purchase agreements, use business insurance to fund the purchase of the deceased owner's interest in the company. Buy-sell agreements often use business life insurance to fund the purchase of company shares. Corporate risk refers to risks associated with the unique circumstances of a particular company. Businesses use insurance to mitigate and reduce risk. Insurance protects company assets. Business risk management also includes insurance on the company's property (plant, equipment, vehicles) as well as insurance to protect the company in the event of product liability or other lawsuits. At some companies, it might also include health and disability insurance on employees.

There are multiple types of business insurance. Examples include business owner's insurance policies, business liability, workers' compensation insurance, key employee life insurance, business disability insurance, marine insurance, business interruption insurance, computer insurance, business automobile insurance, and crop insurance. Certain types of business insurance are used across businesses and industries while other types are industry specific. Small and medium sized businesses often choose to purchase a business insurance package, referred to as a business owner's policy, that combines coverage into one policy. The diverse ventures and scale of large corporations usually require multiple forms of insurance; sometimes from multiple insurers. In the event of loss, businesses insurance provides, as specified in the particular policy, either actual cash value or replacement value. The following descriptions define the most common forms of business insurance used by U.S. businesses (Anderson, 2001).

Business Owner's Insurance Policy

Business owner's insurance policies combine property and liability insurance together on one policy with one premium. The property coverage may include business buildings, computers, furnishings, phones, records, employee belongings, equipment, and inventory. The liability coverage may include bodily harm, personal harm, or advertising harm. Business owner's insurance policies are most appropriate for small or medium sized businesses with 100 or fewer employees.

Business Liability

Business liability insurance is designed to protect business owners from exposure to liability. Business liability exposures include liability from accidents occurring on business premises or property, products sold by the business, and contractual liability. In some instances, businesses may choose supplemental liability insurance. Supplemental liability insurance provides coverage beyond the limits of the primary policies or additional liability coverage. Examples of supplemental liability insurance include product liability insurance or professional liability insurance. Product liability insurance covers liability for injury to persons or property caused by a company's products. Professional liability insurance includes errors & omissions (E&O) insurance and directors & officers (D&O) insurance and protects the insured from any loss sustained because of an error or oversight on his or her part. Directors & Officers insurance protects directors and officers from liability claims arising out of alleged errors in judgment, breaches of duty, and wrongful acts related to their organizational activities.

Workers' Compensation Insurance

Workers' compensation insurance generally requires employers to pay benefits and medical care to employees for on-the-job injuries as well as pay benefits to dependents of employees killed by occupational accidents.

Key Employee Life Insurance

Key employee life insurance, also referred to as business life insurance, protects a business owner, partners, or operator against the loss of income resulting from the death of a significant member of the firm. Examples of key employees or significant members of a firm include the chief financial operator, human resource manager, head of operations, or knowledge officers.

Business Disability Insurance

Business disability insurance protects business owners or partners against loss caused by a partner's disability. Business disability insurance also reimburses businesses for loss caused by the disability of a key employee.

Travel Insurance

Travel insurance protects businesses from accidents that occur while an insured employee is traveling on business for an employer.

Business Property Insurance

Business property insurance protects a business owner or operator from loss associated with damage to business physical property.

Marine Insurance

Marine insurance protects business inventory transported from one place to another by water. In addition, marine insurance may be used to protect bridges, tunnels, and other means of water-related transportation.

Business Interruption Insurance

Business interruption insurance protects a business owner or operator against financial losses resulting from an interruption to business operations or other insured peril. Business interruption insurance provides reimbursement for lost business profits and expenses necessary for continuing or reopening the business.

Computer Insurance

Computer insurance protects businesses from failure of computer software and hardware. Businesses increasingly rely on their technology systems to store information and reach customers. Some of the risks not covered by conventional insurance include computer viruses, electrical surges, lightning, auxiliary equipment, and sewer backup and flooding. Computer insurance covers extra expenses, mysterious disappearance/theft, loss of income, valuable papers and records, and utility interruption. Computer insurance generally excludes programming errors, mobile equipment, and the costs of temporary business locations (Yudkowsky, 1998).

Business Automobile Insurance

Business automobile insurance protects business owners, operators, and employees from liability associated with the operation of business vehicles and protection for damage to the vehicle itself. Examples of business vehicles include private passenger cars, livery cars, pickups, and light vans. Factors that influence premium rates include the number of insured cars, passive restraint systems, driver training, mature driver credit, antitheft device in autos, burglar car alarms, antilock braking systems, violation-free driving records. In some instances, businesses elect to purchase supplemental business automobile insurance such as non-owned auto liability coverage. Non-owned auto liability insurance covers a business's liability when employees or volunteers use their own cars while attending to company business. Businesses with 25 or more low- or medium-priced vehicles generally self-insure comprehensive and collision coverage (Trupin, 1994).

Crop Insurance

Farm businesses depend on crop insurance to protect themselves from the loss associated with low crop yield or falling crop prices. The U.S. Department of Agriculture has a risk management agency to assess, oversee, and implement the federal crop insurance programs. Federal crop insurance programs were established following the Great Depression of the 1930s to aid farmers in their recovery and to boost American food-growing capacities. The Federal Crop Insurance Corporation was established in 1938 to facilitate, support, and subsidize transactions between farmers and private insurers. The Federal Crop Insurance Act of 1980 expanded the crop insurance program to many more crops and regions of the country. The U.S. agricultural price support system and crop insurance includes protections for wheat, corn, oats, soybeans, cotton, sugar, peanuts, tobacco, rice, milk, and other goods (Marcus & Modest, 1986). The Federal Crop Insurance Act strengthened the crop insurance program as a means of replacing expensive government disaster assistance programs. Two of the most common forms of crop insurance include commodity-level revenue insurance and whole farm revenue insurance. Commodity-level revenue insurance, for crops such as corn, soybeans, and wheat, is a specialized form of crop insurance and a major part of the subsidized Federal crop insurance program. Whole-farm revenue insurance, which combines revenue from all the crops produced on a farm, is a broad-based approach to crop insurance (Dismukes & Glauber, 2005).

Issues

Business Insurance & Risk Management

In corporate environments, business insurance is used to manage both speculative and pure risks. Risk managers use business insurance, along with other financial instruments and tools, to mitigate risks faced by the company. Risk evaluation, classification, and management are undertaken for large and small projects and organizational decisions. Identifying and mitigating risk is the primary role of risk managers (Klinke & Renn, 2002). The potential benefits of risk management practices include the reduction of the expected deadweight costs of bankruptcy, minimization of tax payments, and protection of optimal investment programs. Risk management is an outgrowth of insurance management. While corporate insurance in the United States dates back to the nineteenth century, the practice of corporate risk management did not emerge until the 1960s. The adoption of risk management practices was slowed by the lack of professionals trained in risk management strategies.

While risk management was practiced in the 1960s and 1970s by public and private organizations, corporate risk management was not widely adopted until the 1980s. The 1980s were characterized by increasing government regulations, a growing economy, and insurance crisis. The federal government passed laws, such as the Occupational Safety and Health Act, the Environmental Protection Act, and Superfund legislation, which require corporate compliance. Corporations created new positions, such as risk manager, to address liability, safety, and environmental compliance issues. In addition, the business-boom of the mid 1980s (characterized by an increase in production plants, business locations, operations and workers) required new types and larger amounts of insurance. Companies demanded more insurance options and coverage from their insurers and insurance companies balked at the demands. Companies struggled both with financing their increasing insurance needs and finding insurance policies that met the needs of their expanding businesses. Corporations increasingly hired risk managers to assess their business risks and select the best insurance options for their expanding businesses.

Insurance companies, in response to the of events such as the September 11, 2001 attacks on the World Trade Center, the collapse of the Enron Corporation, and the unstable global geopolitical risk, are increasingly unwilling or unable to insure pure risk. Insurance companies are increasingly requiring shared risk scenarios with corporations and governments. Geopolitical risk refers to any peril that arises from geographic, historic, and societal variables related to international politics. The insurance industry, federal government, and business sector have responded to the instability in the geopolitical climate and heightened sense of risk for corporations through two main tactics. First, companies are developing their own forms of self-insurance, such as captive insurance, when outside insurers are unwilling or unable to insure a risk. Second, the insurance industry and federal government are forming alliances, as is the case with terrorism insurance, to create insurance options for businesses. The insurance industry, federal government, and business sector are working cooperatively to weather the risks resulting from the increasingly unstable geopolitical environment.

Captive Insurance

Captive insurance refers to an insurance company that is owned by the parent company that insures, or reinsures, the risks of the parent company. Captive insurers protect employees, and their dependants, against loss of earnings, or savings, due to illness or accidental injury, disability or death. Benefits covered by captive insurance include death benefits in lump sums; death benefits in dependants' pensions; personal accident benefits; short-term sickness benefits; long-term disability income benefits; medical and hospital expenses benefits; and retirement benefits. Organizations use captive insurance to lower the costs for many kinds of business insurance and to keep control of financial assets that would, in other financing situations, be funding the insurance costs. Captives offer numerous advantages including gaining control over reserves and investment return; evening out rates for individual country operations; providing coverage not readily available in the commercial market; and improving health care costs by analyzing health related trends and offering managed care in place of increased rates (Cole, 2001). Captive insurers were first used in the mid-19th century and have been used as a benefit risk management tool ever since. Ultimately, risk transfer mechanisms are an expanding risk financing option for corporations interested in maintaining complete control over their risk management operations.

Terrorism Insurance

While captive insurance is an example of business insurance that is developed, implemented, and managed within a business or group of businesses, terrorism insurance is an example of a form of business insurance that is created and negotiated by government and insurance actors. Terrorism insurance has been reworked and remade in response to the events of September 11, 2001. While insurance coverage has historically included coverage for terrorism risk, the magnitude of the losses resulting from the September 11, 2001 attacks on the World Trade Center demonstrated to the private insurance industry that terrorism insurance was too great a risk to undertake without government backing. The Terrorism Risk Insurance Act (TRIA) of 2002, implemented by the U.S. Department of Treasury, established a temporary partnership between the private insurance industry and government insurance programs to cover losses from foreign terrorist attacks on American soil, ships, aircraft, and international missions. The law calls for a transparent system of shared public and private compensation for insured losses resulting from acts of terrorism. President Bush extended the Terrorism Risk Insurance Program from December 22, 2005 through December 31, 2007. In 2013, the program was still in effect, though once again in danger of expiration in 2014. The government has two main goals for the Terrorism Risk Insurance program. First, the federal government desires to protect consumers by addressing market disruptions and ensuring the continued widespread availability and affordability of property and casualty insurance for terrorism risk. Second, the federal government intends to allow for a transitional period for the private markets to stabilize, resume pricing of such insurance, and build capacity to absorb any future losses all while preserving state insurance regulation and consumer protections (Robinson, 2005). As a result of changes in the geopolitical environment and globalization in general during the late twentieth and early twenty-first centuries, business insurance and risk management have become inexorably linked. Ultimately, captive insurance and terrorism insurance are two examples of business insurance types that have evolved to meet the needs of contemporary businesses.

Conclusion

In the final analysis, business insurance, which includes business owner's policies, business liability, workers' compensation insurance, key employee life insurance, business disability insurance, marine insurance, business interruption insurance, computer insurance, business automobile insurance, and crop insurance, is used by businesses for deferred compensation funding, buy-sell agreements, and corporate risk management. Due to the importance of business insurance to the proper financing and functioning of businesses, insurance experts recommend that businesses conduct an annual checkup to assess whether or not their current coverage protects the business from relevant risks (Papilia, 2004).

Terms & Concepts

Business Automobile Insurance: A category of insurance that covers liability for injuries caused by company vehicles and employee vehicles when used for a business purpose.

Business Insurance: A category of insurance coverage purchased to protect against loss exposures and risks of business firms.

Buy-Sell Agreements: An agreement used by businesses to sell the interests of a deceased owner to the remaining partners at a predetermined price or using a predetermined formula.

Captive Insurance: An insurance company that is owned by the parent company that insures, or reinsures, the risks of the parent company.

Deferred Compensation: An arrangement in which a portion of an employee's income is paid out at a date after which that income is actually earned.

Geopolitical Risk: Any peril that arises from geographic, historic, and societal variables related to international politics.

Insurance: A contract under which one undertakes to pay or indemnify another as to loss from certain specified contingencies or perils.

Key Employee Life Insurance: A category of insurance that protects a business owner, partners, or operator against the loss of income resulting from the death of a significant member of the firm.

Pure Risk: A category of risk that results exclusively in loss and failure.

Risk Management: The process of evaluating, classifying, and reducing risks to a level acceptable by stakeholders.

Speculative Risk: A category of risk that, when undertaken, results in an uncertain degree of gain or loss.

Bibliography

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Penafiel, K. (2013). Congress must act on Terrorism Risk Insurance Program. Buildings, 107, 30. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=87687031&site=ehost-live

Robinson, R. (2005). Private, government terror cover is possible. Business Insurance, 39, 11-11. Retrieved July 17, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=15873471&site=ehost-live

Trupin, J. (1994). Auto insurance: The three Cs. Journal of Accountancy, 177, 42-44.

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Zales, B. (2013). Insured for business interruption? Know this. Northern Colorado Business Report, 18, 19. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90536745&site=ehost-live

Suggested Reading

Bloomer, J. (2004). Impact of insurance accounting on business reality and financial stability. Geneva Papers on Risk & Insurance — Issues & Practice, 29, 56-62. Retrieved July 17, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=11680700&site=ehost-live

Greenspan, S. (1978). Getting the most from your insurance: Measures to take before and after a loss. Management Review, 67, 33. Retrieved July 17, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=6023933&site=ehost-live

Shusterman, R., Miscioscia, A., & Rosenthal, P. (2005). Liability insurance coverage for construction defect claims. FDCC Quarterly, 55, 493-534. Retrieved July 17, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=19741884&site=ehost-live