Commercial – How Much Insurance is Enough?
When purchasing commercial insurance, it is important to buy the right forms of coverage and the right amount for your particular circumstances. Since no two businesses or industries are alike, it is near impossible to summarize all of the considerations. However the following considerations may stimulate the business owner’s thought process when considering the limits of insurance to purchase. For ease of understanding, the following generalizations are categorized as Physical Assets or Liability.
Physical assets include all of your businesses physical possessions including the buildings from which you operate (owned or rented), improvements and betterments made to rented or leased facilities, your business personal property (equipment, material, supplies), vehicles used in your business and other items that are subject to insurable perils.
Buildings – For many businesses, the cost of their building(s) can be the largest single asset. But yet according to industry research, most building(s) owners are under-insured. There are a variety of reasons why this takes place including building material inflation, failure to increase coverage after building(s) improvement upgrades and the booming real estate market, but the fact remains, in the event of a major loss, coverage is inadequate in the majority of instances.
It is extremely important that coverage purchased is on a replacement cost basis (as opposed to Actual Cash Value which reflects depreciation), that limits purchased accurately reflect what it would cost to rebuild your building(s) in its entirety up to current building code for commercial buildings and that coinsurance requirements are met. When considering the replacement cost consider the building(s)’s features, its size, the nature and quality of the construction, the materials used and where it is located.
It is also very important to remember that the replacement value of your building(s) can vary significantly from its actual purchase price, its market value, its assessed value, its appraised value for taxes and its book value, as carried on the balance sheet of your business and reflects book depreciation.
Coinsurance – Another very critical feature often misunderstood is coinsurance. Coinsurance exists to reward the person who carries the proper insurance-to-value and to penalize the person who does not. If a person agrees to insure to 80, 90 or 100% of value, a credit is provided. If a person chooses to not insure to that amount, a surcharge is exacted at the time of loss. Coinsurance serves as a penalty for not carrying adequate insurance to value. As a result, instead of the insurance company paying the entire loss, the policyholder becomes a co-insurer and pays a portion of the loss. Coinsurance is the percentage of replacement cost value that the policyholder is required to insure. A building with a value of $1,000,000 and a policy with an 80% coinsurance clause must be insured for at least $800,000. To make life more complicated, “value” is determined at the time of the loss. If the amount of insurance is found to be under the coinsurance percentage then a penalty is applied reducing the claim payment. Almost every form of property insurance (buildings, contents, business interruption, etc.) contains coinsurance clauses.
Business Personal Property – It is very important to determine the value of all of the businesses personal property and contents and to insure this amount. Similar to the building insurance, the contents are subject to coinsurance requirements so failure to maintain adequate coverage may result in a penalty. Items to be considered include furnishings, equipment, raw material, finished product, computers, communications equipment, etc.
Equipment Breakdown – Since this form of insurance covers damage from “internal” causes such as mechanical failure, electrical short circuit or “arcing” (faulty wiring or motor burnout), it is important to estimate the value of the equipment, loss or damage to perishable product that could be effected by the breakdown as well as the loss of earnings due to the interruption of normal business.
Business Interruption – Business Interruption insurance protects a business owner if the owner can not conduct business due to a covered loss such as fire, utility failure and other unexpected event prevents the business from operating. Since this coverage pays for the company’s loss of profit as well as expenses that continue while the business is not fully operational during repair or relocation following a loss, it is important to accurately estimate the potential financial loss and the time it will take for the business to get back to normal. Care should be taken to accurately project earnings and expenses based upon historical data because as with other major forms of property insurance, business interruption is subject to coinsurance requirements. Typically this coverage is written on either an Actual Loss Sustained basis or an Agreed Amount basis. The difference between the two is that the amount of coverage is determined after the loss with Actual Loss Sustained whereas, the amount of coverage that exists is known beforehand with the Agreed Amount approach. Kettle Creek would be pleased to help you determine the amount of business interruption insurance your business should purchase using proprietary tools developed for this purpose.
Ordinance or Law Coverage – This insurance protects a building owner from the increase costs of a loss due to the enforcement of building, zoning, or land use laws. The endorsement covers the increased cost of repairs, reconstruction, demolition and removal costs that arise because of enforcement of laws. There are three parts to this coverage. Coverage A deals with laws that require a building is torn down if more than a predefined percentage is destroyed and the building does not meet current building codes. Coverage B pays for the demolition of the undamaged portion. Coverage C pays for the increased costs to bring the building up to code in order to gain permits to rebuild. Generally speaking, the older the building the greater the limits required. Care should be taken in determining the appropriate limits of Ordinance and Law coverage.
Auto Physical Damage – Auto insurance blends several types of coverage into one policy including: physical damage to your automobiles, trucks and other motor vehicles, bodily injury and property damage liability, medical and uninsured and under-insured motorist’s coverage. In terms of physical damage to your automobiles, trucks and other motor vehicles, coverage is primarily available on an Actual Cash Value (“ACV”) basis. In essence, with ACV the customer’s recovery is determined after the loss and is based upon the published value of the car and its perceived pre-accident condition as determined by a claims adjuster.
Workers Compensation and Employer’s Liability
There are two parts to Workers Compensation insurance. Part I covers accidents and occupational diseases that happen during the “policy period.” An employer’s entire statutory liability under the law is insured under the policy. Part II Employers liability insurance protects the business owner against tort or other liability for “damages,” as opposed to the statutory liability for workers compensation “benefits” under workers compensation law. In this instance, it is possible to purchase higher limits than the standard limits of $100,000 Each Accident, $500,000 disease policy limit and $100,000 disease per employee. In addition, the Umbrella policy will insure excess of the employer’s liability.
Personal Liability pays for liability arising from accidents that are incurred on your premises, from your actions or as a result of your activities. Liability includes but is not limited to damage to the property of others, bodily injury, contractual liability and personal injury to name a few of the types. Having adequate limits is imperative.
Third Party Liability – As a rule of thumb, Kettle Creek believes that the limits of liability purchased should be equal to or greater than the total market value of all of your business assets including buildings, real estate, business personal property, financial assets, “franchise” value and “reputation” value.
The Building Blocks – We generally recommend buying $1,000,000 per occurrence with a $2 million aggregate of commercial general liability insurance and $1,000,000 in liability limits as part of the Business Auto Policy. This also applies to professional liability as well as other specialty lines such as liquor liability. Supplement the underlying policies with a Commercial Umbrella Liability Policy such that the sum of the underlying liability limits purchased plus the umbrella liability policy limit is equal to or greater than the market value of all of your assets. The following graphic conceptually portrays the thought process:
What Actions You Should Take
So what should you do to be sure you are adequately protected?
- Prepare an inventory. Determine the replacement cost.
- Determine the market value of all of your business assets.
- Consider your business’s potential loss exposures (building(s), equipment, services, products, employees, etc.);
- Consider the “market value” of your business.
- Consider the business’s reputation and customer base in assessing its market value.
- Review your policies to be sure you are properly covered. Know what is covered and what is not covered.
- Call Kettle Creek Insurance Agency at: 203-222-9052.