Introduction to Business Insurance

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Business insurance is a broad category of insurance coverages designed for businesses. It is also called commercial insurance. Businesses buy insurance to protect themselves against financial losses resulting from lawsuits or physical damage to company-owned property. Insurance helps ensure that a business can continue to operate after a loss occurs.

Protects You Against Large Losses

Business insurance is designed to protect a company against catastrophic losses.

Examples are a fire that destroys a building, and an auto accident that generates a large lawsuit against the firm. Such events can be very costly. If they are not insured, they could cause a company to go bankrupt.

Business insurance is not intended to cover small losses that a company can easily absorb. This is the reason many policies contain deductibles. For instance, a commercial auto policy typically includes a deductible that applies to physical damage coverage. If the policy covers collision damage, the insurer will not pay for a small "fender bender" loss that does not exceed the deductible.

Some risks cannot be insured under standard insurance policies. Examples are earthquakes and floods. These hazards require specialized coverage. A few risks are uninsurable. For instance, you cannot insure your building against damage caused by war or nuclear radiation.

Spread of Risk

The primary purpose of insurance is to spread risk.

All businesses face the risk of a catastrophic loss. For any one business, the odds of a major loss are very small. Yet, large losses do occur, so every business needs to protect itself by buying insurance. The business pays a premium, and in exchange, the insurer assumes the risk that large losses will occur.

Insurance companies collect money from insurance buyers in the form of premiums. Insurers are required by law to hold some of that money as reserves. They invest these funds so they can earn income on them. Insurers use some of the money they've set aside to pay claims.

Insurance companies have developed loss prediction tools based on a mathematical rule called the law of large numbers. This law is essentially the idea that loss prediction becomes more accurate as the number of exposure units increases. That is, insurers are better able to predict losses when they are insuring many widgets rather than a few.

For example, suppose an insurer is insuring six buildings. Because the number of exposure units (buildings) is so small, the insurer cannot accurately predict how many of them will sustain a fire loss within the next year. The insurer's ability to predict fire losses will improve significantly if the insurer is insuring six million buildings instead of six.

Insurers collect and analyze loss data for each industry.

They use historical loss data to predict future losses. Insurers use this data to develop the rates they charge policyholders. Businesses in risky occupations pay higher rates than those in low or average-risk occupations.

Steps to Buying Insurance

Buying insurance for a business is a process that involves four key steps.

Educate Yourself
Before buying insurance, you should have a basic understanding of the types of policies businesses purchase. It may be helpful to ask other business owners in your industry what insurance coverages they have. Most businesses need general liability, commercial auto, commercial property, and workers compensation policies. You need not understand all aspects of these policies, but you should know what purpose they serve.

Analyze Your Business
The next step is to assess your business to determine the specific coverages your business needs. Prepare a written description of your business, explaining what is does and how it operates. Create a flowchart that describes each step of your operations. Make a list of the property your business owns.

Choose an Agent or Broker
Insurance is a people business. You'll need an agent or broker with whom you can develop a long-term relationship. This person should be a licensed professional with a good knowledge of insurance coverages. He or she should also understand the insurance marketplace. Give your agent your written description of your business. Provide any additional information he or she requests. The more your agent knows about your business, the better he or she will be able to meet your insurance needs.

Review Your Insurance Coverages Regularly
Your business isn't cast in stone. It will grow and change over time. Your insurance policies need to reflect those changes. You may need additional coverages, or higher or lower limits. Meet with your agent or broker once a year, before your policies renew, to assess your coverages.

Article edited by Marianne Bonner

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