Mandatory vs. recommended vs. necessary – what types of insurance are really must-have for your business?
Small businesses face a multitude of risks. The risks of not being able to make a decent return on investments or break even are usually the ones that immediately come to mind. However, there are many other risks involved: the risk that key assets of a business can be damaged, the risk of being held liable for a defective product, the risk of an employee getting injured on the job, etc., the possibilities can be numerous.
This is why there are insurance policies available for small businesses. Some of these are required by law, others may not be required but they are recommended or considered as must-haves.
General types of small business insurance
The U.S. Small Business Administration identifies these two types as:
- Employer Insurance which is required under law; and
- Commercial Business Insurance which is not a requirement in many states.
Types of Employer Insurance
For small businesses that employ workers, state law requires that they are to purchase certain types of coverage. These insurance requirements are as follows:
Small companies that have people under their payroll are required to have this type of policy. They can have this type of plan via a commercial insurance provider, under a state compensation insurance program for workers or they can provide them on their own in a self-insured manner. A more detailed discussion about this type of policy is provided in our guide: "Workers compensation - learn the ropes in a single guide."
Small businesses that employ workers and operate in any of these states and territory: Rhode Island, Puerto Rico, New York, New Jersey, Hawaii and California, are to required to purchase this type of insurance. The following links show state level information about this insurance. Simply use the search function of these sites and type "disability insurance."
- Rhode Island: www.dlt.ri.gov/.
- Puerto Rico: www.dtrh.gobierno.pr/
- New York: www.wcb.ny.gov/
- New Jersey: www.state.nj.us/labor/tdi/
- Hawaii: www.hawaii.gov/
- California: www.edd.ca.gov/
For small businesses that are found in other areas, this type of policy is not a requirement under law. If a business opts to provide disability insurance as part of a package of employee benefits, it may do so by purchasing coverage via commercial insurance providers.
Unemployment insurance tax
Small businesses that employ workers are required under law to pay taxes related to unemployment insurance. The UI tax program is a joint effort between the federal and state governments. In general, employers are required to pay both federal and state UI taxes under the following conditions:
- The wages they pay to their workers total $1,500 or greater in any given quarter of a year
- They employed at least a single worker during any day in a week in twenty weeks in a year, regardless if these weeks are consecutive.
In certain states, the law on unemployment insurance may be different from federal law. For an overview of the unemployment insurance program, go to: http://workforcesecurity.doleta.gov/unemploy/pdf/partnership.pdf.
For state-specific information on UI tax, go to: http://workforcesecurity.doleta.gov/unemploy/agencies.asp.
Types of Commercial Business Insurance
In many states, most of these types of coverage are not a requirement under law. However, small businesses should consider them as they may provide protection against uncertain events.
There are 4 categories, which this type of policy covers: bodily injury, damage to property, personal injury to include libel and slander and also misleading or false advertisement.
This policy does not include the workers employed by a business as they are protected by workers' compensation. This plan offers coverage for:
- Compensatory damages (for losses that are financial in nature), which the injured party suffered,
- General damages (which are non-financial like "mental anguish" or "pain and suffering") as claimed by the injured party, and
- Punitive damages, which are charges and penalties that the business must shoulder in relation to a claim.
A small business has a duty ensuring that its products are safe to use. This type of policy provides coverage for costs associated with claims arising from the use of products that a business makes or supplies, which cause injury, damage or turns out to be faulty.
This type of policy does not cover products that do not meet industry standards. Hence, an insurer would like to see that your workers and manufacturing processes are qualified before approving a policy.
For small businesses that offer services, this type of coverage can help them absorb losses that arise because of errors, malpractice as well as negligence in the delivery of those services.
This policy is usually set up following a claims-made basis. This means that coverage is only available during the time the policy is in force - claims made in relation to prior incidents are not covered.
What is not covered under this plan are: legal liabilities as defined by civil law and also criminal prosecution.
Those who may need this type of policy include: attorneys, accountants, consultants, doctors, dentists, financial planners, occupational therapists, computer analysts, and real estate agents.
In certain states, this type of insurance is required from certain professions like doctors. The American Medical Association lists the following states where doctors are required to purchase this insurance: Rhode Island, New Jersey, Massachusetts, Kansas, Connecticut, Colorado, Wisconsin, Wyoming, Pennsylvania, New York, New Mexico, Nebraska, Louisiana and Indiana.
This type covers the business' properties in case they get damaged because of certain perils. This also covers losses arising from theft. Some examples of business or commercial properties include:
- Computers and similar equipment
- Valuable documents, books
- Antiques and artwork
- TV sets, DVD/VCRs, satellite dishes
- Items that are not tangible like copyrights and trademarks
Commercial property policies come in three types: Basic, Broad and Special.
- Basic plans cover financial loss arising from hail, fire, explosion, lightning, fire and windstorm. In addition, it also pays for removal of properties for prevention of further damage.
- Broad plans are essentially basic plans plus add-on coverage for other perils like civil unrest, riots, etc.
- Special plans may include features found in basic and broad policies plus all physical losses that arise as a direct result of a covered peril.
Commercial property insurance payouts may either be based on the cost to replace a property or its actual cash value.
This provides coverage for earnings lost as a result of a circumstance covered under a property insurance policy. Hence, it is usually purchased as an add-on to a property insurance plan. This is important as it ensures that regular expenses such as utility payments and salaries do not get affected.
This is for homeowners who run their small businesses in their homes.
Usually homeowners insurance does not include losses that are related to a home-based enterprise. This is where this type of coverage comes in. In certain cases, this can be purchased as a rider or add-on to a regular homeowners plan.
However, coverage for professional as well as general liability may have to be purchased separately. For further information about this type of policy, read our guide "How to properly insure your home-based business."
Many states require car insurance policy regardless whether the car is used for business purposes or not. Cars that are utilized by a small business should have coverage for accidents that are business-related because the standard auto insurance policy may not provide for this.
Auto insurance for small businesses may appear similar to a standard policy. However, the difference lies in liability limits that a commercial auto policy usually carries. Also, there are provisions that deal with rented vehicles as well as cars owned by company workers, which are used in relation to the business.
To establish whether this policy is needed by your business, consider:
- ownership of the car
- who drives the car
- how the car is used (for example, delivery of packages, transport of people, transport of toxic materials, etc.)
How to know which type of commercial insurance your business needs
Make an assessment of your risks. See what areas of your business are you likely to face considerable losses in the event something unpleasant happens. It could be the product your are making or distributing, the services you provide, the advice you give, the assets your business owns, or how your business operates (for example, does it regularly transport hazardous materials, or, do you operate in a community where there is high risk of property theft?).
Consider these steps on risk assessment and management:
- Identification of areas of potential losses. This can include injury claims, theft and casualty losses, embezzlement and fraud, etc.
- Make an evaluation of each area. See the frequency of the event and the severity of its impact on the business.
- See what is the best way to manage the risk involved. Will you be able to control or eliminate it? Is it possible to have the risk transferred to an insurance provider?
Be aware of your state insurance laws. Your state may require your business to purchase a type of insurance.
Be a wise shopper. Compare the choices available to you. If you think you feel overwhelmed by what the market offers, consider getting the services of a trusted agent. Do your research and check consumer feedback.
Opt for a Business Owner's Policy. A BOP is a package of policies that is tailored for a typical small business. This can save you money instead of buying separate policies. Usually, a BOP offers property, liability, auto, business interruption as well as other common types of commercial insurance. Be sure that a BOP fits your business' needs before buying one. You may have risks that are unique and not covered in a BOP.
Do a yearly assessment. A small business may see itself growing - along with this the insurance needs also grow. Hence, it is important to make an annual assessment. There may be new assets added to a business that are not covered by current policies. New products and services may be inserted and these too need to be assessed.
What type of commercial insurance to avoid
Commercial insurance policies are either written as "claims-made" policies or "occurrence" forms. Small business owners are advised to get occurrence form policies.
First of all, let us distinguish between the two:
Claims-made insurance offer coverage only for claims that fall within the time frame the policy is in effect. In this type of policy, as long as you pay your premiums, you are covered. When you stop paying the premiums, your business faces the risk of unreported claims, which can emerge later on. To extend coverage, you have to buy an add-on - "tail" coverage for claims made after the policy has elapsed.
Occurrence coverage, on the other hand, provides protection against claims made even after the business owner has stopped paying the premiums. For instance, a private investigation business purchased an occurrence coverage plan in 2005 and the business owner stopped paying in 2010. An individual who was followed around by the business in 2006 made a claim of Invasion of Privacy against the business in 2012 which is after the business owner stopped paying insurance premiums. The occurrence coverage plan will cover this claim.
While an occurrence coverage type of insurance is ideal, be informed that it can be more costly - sometimes by as much as 50 percent compared to claims-made policies.