Part 2: Adequacy of Coverage

In the first installment of this series on insurance, we discussed some common scenarios where an organization might have an expectation of coverage but where coverage might not exist. In this post, we will discuss ways to gauge whether your organization has sufficient policy limits for each area of potential risk.

Protection Where You Need It Most

In the first installment, we discussed commercial general liability (CGL) policies. CGL is a common type of insurance coverage, and all organizations vitally need it. These policies cover a broad assortment of loss categories and provide coverage from everything to customer injuries on your business premises to defense costs in litigation to electronic data loss. However, as discussed in the first installment of this series, CGL policies do not cover everything and they need to be supplemented with other policies.

In addition to a CGL policy, your business will likely need policies that cover other loss areas, depending on its activities. For instance, if your business or organization engages in activities that might be considered professional services or advising clients, you will need professional liability insurance. Often called an “Errors and Omissions Policy” (or “E&O” for short), a professional liability policy will provide coverage for instances when your business or its professional employees are sued for negligently providing services. Examples of businesses that need professional liability coverage include consulting firms, law offices, insurance agents, real estate agents, and financial advisors.

If your organization has employees, you will also need workers’ compensation insurance to compensate workplace injuries. This area of insurance is highly regulated and is usually required by state law, so you will want to ensure that your workers’ compensation insurance complies with applicable law.

If your organization owns valuable tangible or real estate assets that are subject to damage, it may be a good idea to get property insurance. Coverage for an insured’s property damage is generally not included in CGL policies. If your organization requires employees to operate company-owned motor vehicles on the road, you will also need a commercial auto policy.

As discussed in the first installment, CGL policies often specifically exclude coverage for things like employment practices, abuse and molestation, and intentional injuries. Therefore, if the activities of your business or organization risk events of loss that might fall under these exclusions, you will need a specific policy that covers such categories with adequate coverage.

These are just a few examples of the various kinds of insurance policies your business or organization might need, depending on the nature and scope of its activities.

How Much is Enough?

In the world of insurance, there are two dimensions: breadth and depth. Both are crucially important. A business may have a broad base of coverage in terms of the various policies that it has to cover a multitude of different loss categories. However, if that business has coverage limits that are insufficient to cover losses when they arise, then the coverage is not “deep” enough. Just having an applicable policy that provides coverage for a given category of loss is of little use if the limits on those policies are not enough to provide meaningful coverage.

When assessing the amount of coverage your business needs under a given policy, you need to evaluate the risk that faces your business. Like insurance, risk itself is something that can be understood in two dimensions: probability of loss and magnitude of loss. Probability of loss is the likelihood that a given event might occur. Magnitude of loss is the severity of damage that will result if that event does occur. An event might have a low likelihood of happening, but a high magnitude of loss if that event happens.

For example, hurricanes often result in catastrophic damages to retail establishments, but if you run a store in southern New Mexico, it’s fair to say that your business is unlikely to get wiped out by a hurricane. This is an instance where the magnitude of potential loss is very high, but the probability of loss is negligible. A high-premium policy for flood insurance with $5 million in coverage might not be reasonable for such a business under most circumstances. However, if you were to open a new location on the Gulf Coast, that’s a different story.

To evaluate the amount of coverage your business needs for a particular category of loss, you must take into account the likelihood that an event would happen as well as the severity of loss that would occur if it did. To use a more concrete example, if you operate a daycare, you certainly hope and pray that no serious harm would come to any of the children under your care and control. Such a tragedy may be very unlikely, especially if you take significant steps to screen employees, monitor children, and implement safety measures at your facility. Nevertheless, if serious harm such as death, bodily injury, abuse, or molestation were to occur (or even allegations of such things), the magnitude of loss would simply be astronomical. This is why a childcare facility could justify paying higher premiums for insurance that not only provides coverage for those loss categories but provides such coverage with substantial policy limits.

Balancing Coverage and Costs

Insurance, of course, is not free, and the more coverage you get, the more it costs. Higher coverage limits equal higher premiums. The cost of insurance is a significant operating expense for most businesses, but the cost of being underinsured is much higher. There are at least three factors to consider when ensuring you have sufficient insurance in place: (1) having coverage for all the areas you need; (2) having sufficient policy limits to cover losses when they arise, and (3) costs. Balancing these three factors may take a greater investment of your time and attention than a simple internet search or deference to your insurance agent, though a good insurance agent will be enormously helpful as you do the analysis. Businesses and organizations must be smart, efficient, and well-informed when it comes to the insurance policies they obtain.

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Featured Image by Rebecca Sidebotham.