How to Buy the Right Business Insurance

Your business faces plenty of threats -- from fire to fraud, from dishonest employees to discontented customers to disconnected utilities. And yet for nearly every peril, some insurance company somewhere is willing to underwrite protection. Therein lies your dilemma: You can go broke keeping your company secure.

The agents, risk managers, and small-business consultants Inc. spoke with warned that insurance purchases can be driven by exaggerated fears, particularly of litigation. So before shopping for coverage, investigate what perils a company in your industry is most likely to face -- and which could threaten your company's survival. "It's not the run-of-the-mill loss you should be thinking about, but the home run, out-of-the-park catastrophe," says David Young, a former insurance broker and risk manager now advising at the Small Business Development Center in Seattle. Belinda Pillow, who runs the SBDC in Waco, Texas, and who used to sell insurance, recommends a call to your trade association. "Ask for any risk assessment tools for, papers on, or expert opinions about your particular industry," she suggests.

These pages will walk you through some of the most common types of coverage. You probably won't need them all; some you likely already have. Even if you think you're covered, however, you may be mistaken. Companies much larger than yours have gone to the mat with their insurers and come up empty-handed. Your task when buying insurance is to steel yourself for the mind-numbing language of the policy -- and to know precisely what's covered and what's not. If you don't see the coverage you're looking for, or you don't understand some of the terms, seek clarification from your agent.

Insuring Your Business

1. What Everyone Needs

Workers' compensation insurance is required virtually everywhere. (The requirement kicks in at different employee counts in different states.) For injuries sustained on the job, workers' comp covers medical expenses, lost income, and rehabilitation. If an employee dies, it pays death benefits to the heirs. Though it's not mandatory, be sure to cover yourself as well as your employees, something many owners neglect to do even though, Young says, "the premium for owners is usually dirt cheap."

Property insurance, which protects buildings and their contents, such as equipment, furnishings, and inventory, is the most popular kind of protection for small businesses. But it may also be an area in which you are overinsured: Companies with little invested in premises and little inventory can sometimes forgo it. For everyone else, it's as essential as homeowner's coverage (and inevitably required for financing). Be aware that basic policies may exclude certain perils and limit certain claims; for instance, losses from water, earthquakes, boiler problems, and utility failures are often excluded unless you add a rider.

General liability coverage is less common than property insurance among small companies but arguably more important, because a claim for serious injury could easily wipe you out. Liability (a.k.a. casualty) insurance covers any injury or damage your company might cause other people, their reputation, or their property. Any company with premises that other people (customers, suppliers, etc.) can enter, or with a product whose failure could hurt or destroy, should have it. Most standard policies provide $1 million of coverage per claim. You may need more to do business with certain companies, and that's typically purchased under an umbrella policy. An umbrella will often lump together other types of coverage. Insurers price liability premiums according to a variety of measures; revenue and retail square footage are common ones.

Business owner's policies combine property and general liability coverage. (Manufacturers and most construction companies are ineligible for BOPs, however.) Business owner's coverage is usually available to companies with up to $3 million in revenue, though sometimes larger companies can get it. It's less expensive than buying separate policies, and insurers usually throw in other coverage, such as business interruption (see below), for a nominal cost. "I'd say it's 25 percent or even 50 percent cheaper," says Joshua Smith of Insurance & Risk Managers in Brookhaven, Mississippi. "And it's less work on our end, so everybody wins."

2. For Growing Companies

Business vehicle insurance can be configured to cover cars and trucks your company owns, leases, rents, or simply uses. Experts recommend this coverage even when an owner or employee uses a personal car for work, because while personal auto insurance normally permits some business use, when an accident occurs, the insurer will defend only the car owner, not the business. And, Smith says, "any lawyer worth his salt will find out they were driving on company time and drag you into the lawsuit." (And if you drive a company car on your off hours, you'll need a rider to cover that.)

Employment practice liability insurance is a relatively new coverage that's widely recommended. The fact is, behaving decently to employees sometimes isn't enough to avoid a lawsuit these days. The median jury award in employment suits has grown by half in the past decade, but the big exposure is the cost of your legal defense. "The underwriter will throw in the claims for nickels," Young says. Elizabeth Milito, senior executive counsel for the National Federation of Independent Business, urges this coverage for companies with enough employees to be subject to state or federal civil rights laws. (It's not, however, a license to be a jerk. Says Smith: "You might get away with it one time, but if you get a history of that, you'll be uninsurable.")

Business interruption insurance. Hurricane Katrina taught small companies that it's not just the catastrophe you need to worry about; it's what comes after. Business interruption insurance can solve the problem of seeing you through while you rebuild your business by replacing lost income and paying normal expenses. It will also cover extra expenses you incur in getting back into the market quickly. In practice, however, insurers have successfully defended narrow interpretations of these policies. Among the terms you must negotiate with your agent are the waiting period before you can collect (akin to a deductible, it can be measured in either hours or days) and the period for which you'll be covered after business resumes but before it regains full strength. Most important, unless otherwise agreed, basic business interruption kicks in only after a physical loss of property shuts you down. A business owner's policy usually includes business interruption coverage.

3. For Special Circumstances

Key man insurance pays out when an invaluable team member dies or, more commonly, becomes disabled. For many small businesses, the only truly indispensable person is the owner -- in which case it may merely duplicate individual life and disability policies. The exceptions include partnerships, for which these policies are often used to buy out a member or his heirs, and companies in which a particular employee possesses technical or highly specialized skills or knowledge that can't be easily replaced. When you buy it, buy enough to cover the cost of finding a replacement and maintaining support staff and facilities until the new person begins to earn his keep. Key man disability is separate from key man life and usually limited to a percentage of the person's income.

Errors and omissions insurance, or professional liability coverage, is product liability when the product is a service. (Medical malpractice, for example, is a form of errors and omissions.) "If you hold yourself out as an expert giving advice, and someone could be financially damaged in taking that advice, you want to think about professional liability insurance," says Jeff Perlman, an agent in Lawrenceville, New Jersey. Again, the cost of litigation is at least as great as the claims paid out, so make sure the legal defense costs coverage is ample.

Directors and officers liability. Most small corporations don't need it: Their leadership is unlikely to be sued, and when litigation does arise, it's usually covered by another liability policy. D&O begins to matter when companies have outside investors -- according to one survey, nearly a third of private companies reported D&O claims from shareholders in the past decade.

Making A Claim
Here are five tips for making sure you come out ahead in any squabbles over how much your insurer will cover:

Keep Detailed Records. A record of all your transactions, inventories, and assets is key. Store up-to-date duplicates of these safely off-site.

Be Prompt. If you're slow to inform your insurer that you've been sued, and the insurer can argue that your delay prejudiced its ability to defend you, you can lose coverage. Timely notice is especially crucial with so-called claims-made policies, under which coverage is based on when the claim was made rather than when the event took place, says Jay M. Levin, an insurance litigator at Reed Smith.

Follow Up. Check in periodically with the insurer on your claim. If your insurer is mounting a liability defense on your behalf, cooperate with the lawyers the insurer has hired, and keep current on the case.

Know Your Rights. Most states have a version of a model law known as the Unfair Claims Settlement Practices Act, which sets standards for handling claims and prohibits policies that, for example, require you to sue to collect. Read it, and you'll be better equipped to know whether you are being treated fairly.

Hire a Lawyer. The first sign of trouble might come with a "reservation of rights" letter, in which an insurer informs you that while it will defend you in court, it may not (depending on the outcome) pay all of your claim.

Where To Buy It
Agent or broker? Agents may be "captive," working for one insurance carrier, or independent and writing policies on behalf of many companies. A broker is, by definition, independent. It's commonly said that brokers represent you while agents represent insurers -- but the line dividing them is blurring. In practice, "a good agent or broker is an impartial matchmaker, finding the right insurer for the client and the right client for the insurer," says Linda Christ of Cryst & Associates Insurance Agency in Fairfax, Virginia.

Find a specialist. Try to find an agent or broker who specializes in your industry. Such a person knows what risks are paramount to you and has a handle on litigation and settlement trends. You might find tailored and cheaper coverage through your trade association.

Don't trust the Web. If you're tempted by an attractive online quote, make sure there are live agents who can talk you through a policy before you buy it.