Simple strategies small business owners can take to identify and manage top risks
Optimism is the fuel that drives the entrepreneurial spirit, so it isn’t surprising that most small business owners consider themselves optimists. Too much optimism, however, can get a small business owner into trouble. A business plan built solely on the “best case scenario” is like a house of cards—one gust of wind (or fire or wrongful termination lawsuit) and the entire business can come crashing down. That’s why smart business owners temper their innate optimism with a healthy dose of reality. In other words, they learn to manage risk.
The first step in implementing a comprehensive risk management plan is identifying potential risks. To help you get started, we have provided a list of the top 10 threats facing small business owners. As you read through the list, consider the unique risks facing your business and ask yourself whether those risks are being managed effectively.
1. Protecting your Property
Property holdings are often a small business owner’s largest asset. Therefore, for the long-term security of your small business, it is vital that you evaluate potential threats to your property and develop a plan to manage those threats. Begin by taking a complete inventory of all your assets to determine how a loss might affect your business and how much coverage you need. Property coverage can come in many forms to suit your specific needs, but a typical policy will provide the replacement cost value for your building and the actual cash value for your business property.
You have a lot weighing on your budget already, but don’t make the mistake of planning for the “best case scenario” when it comes to your property coverage. Leaving your small business underinsured is a risk too great to take.
2. Business Interruption
The U.S. Department of Labor estimates that more than 40 percent of businesses never reopen following a disaster such as a fire or flood. Is your business prepared to weather the storm if disaster strikes? If a fire causes the facility to be temporarily unusable, what would you do? Ideally, you would move to a temporary location while your permanent place of business is being repaired, but traditional Property Insurance does not cover this move or the loss of income while the permanent business location is being repaired. Ill-prepared businesses are often forced to completely shut down operations during repair, which can do irreparable damage to their brand and leave employees without work for extended periods of time. To mitigate this risk, consider adding Business Interruption coverage to your Property Insurance policy. This invaluable, though often overlooked, coverage safeguards your business by covering operating expenses and lost income while the permanent business location is being repaired. This will allow you to maintain payroll and, if needed, reallocate current employees to help with the cleanup effort.
3. Liability Losses
No matter how well you plan, running a small business can be fraught with unexpected surprises—the only way to completely avoid liability is to shutter your business. Smart business owners do the next best thing: protect their assets by carrying adequate Commercial General Liability (CGL) Insurance coverage. CGL policies provide coverage for claims of bodily injury or other physical injury, personal injury (libel or slander), advertising injury and property damage as a result of your products, premises or operations. A CGL policy with adequate coverage limits enables you to continue normal operations while dealing with real or fraudulent claims of negligence or wrongdoing, and also provides coverage for the cost of defending and settling claims.
4. Key Person Losses
Many small businesses are built around the talents and expertise of a few individuals. If an employee crucial to the functioning of your business departs unexpectedly due to death or injury, would day-to-day operations continue as usual or would disorder and uncertainty ensue? Would you be able to maintain your current level of performance and current revenue stream? How would you cover for the financial loss of the employee or pay for a temporary replacement during his or her recovery? Key Person Insurance can help you answer these questions with confidence. This coverage is designed to provide financial stability in a time of stress and uncertainty, allowing you to keep your business moving forward without missing a beat.
5. Injuries to Employees
Small business owners, especially those with less than 10 employees, often struggle with understanding their employee health and safety obligations. Just like their larger counterparts, small businesses have the same responsibility to indemnify workers who are injured or become ill during the course of their employment. Many businesses do not realize the full effect workplace accidents have on their organization. Beyond initial treatment costs and lost production time, on-the-job injuries have an impact on insurance premiums, which can increase your costs for years to come. Thankfully, by managing exposures and promoting safety, it is possible to control workers’ compensation premiums. Having the proper pre- and post-accident procedures in place can drastically reduce the severity of a workers’ compensation claim, and implementing a comprehensive safety program can reduce the accident rate. Together, these two steps can produce tremendous long-term savings.
6. Managing Electronic Data and Computer Resources
Small businesses often lack a formal IT department or even rudimentary internet security measures, which leaves them vulnerable to unscrupulous cybercriminals searching for an easy target. With an estimated liability of more than $200 per compromised record (multiplied by hundreds or thousands of customer records), the cost of a single data breach incident can be devastating for a small business. If your business stores customer records electronically, it is crucial that you have robust security measures in place. In addition to taking preventative measure to reduce Internet-based exposures, specialized technology coverage, such as Cyber Liability Insurance, can help protect your business against damage from cyber attacks, data breaches and other Internet-based exposures.
7. Environmental Exposures
Think of a business with significant environmental exposures. What comes to mind? Most people think of a large manufacturing, mining or petroleum operation, but these are not the only industries at risk for environmental liability losses. It is important to perform a comprehensive risk analysis to determine your own level of exposure. Keep in mind that because most commercial insurance policies contain pollution exclusions, unless you carry Environmental Insurance, you may be uninsured against significant environmental loss exposures.
8. Employment Practices
From the moment you begin the pre-hiring process until the final goodbyes at the exit interview, you are at risk for a lawsuit. In fact, three out of five employers will be sued by a prospective, current or former employee while they are in business. Although many lawsuits are groundless, defending against them is costly and time-consuming. Your business should take a hard look at whether it can afford to defend itself against accusations of wrongful employment practices. If not, there is an insurance solution called Employment Practices Liability that will protect your company against wrongful termination, discrimination (age, sex, race, disability, etc.) or sexual harassment lawsuits.
When first starting out, many new business owners simply don’t have the time or expertise to adequately evaluate each clause in everything they’re signing. This oversight, however, can create major problems down the road. In many cases, small businesses become saddled with large additional risks, accepted via risk transfer from savvy suppliers or customers. While it’s tempting to shave costs by skimping on legal fees, making sure your business isn’t accepting additional and unnecessary risk can save you a lot of money over the long haul, both in legal costs and in insurance coverage.
10. Manage Your Supply Chain
Do you rely on one or more third-party suppliers to produce certain components used in your products? If you do, a disaster that interrupts your supplier’s regular business operations could have a crippling effect on your production abilities. Although you should always try to minimize potential liability through contingency planning and other risk management techniques, as supply chains grow across the globe, sometimes there is little you can do about the exposures faced by your suppliers. In a perfect world you could simply avoid doing business with companies that present numerous risks or that are unwilling to conform to your standards, but pricing constraints and niche markets limit the number of potential suppliers to choose from. Supply chain insurance is meant to cover losses you incur as a result of an interruption to your supply chain. Such coverage allows you to work confidently with suppliers who face exposures beyond your control.
Insurance is a key component of any comprehensive risk management plan, but successful risk management also involves prevention, training and contingency planning. Contact me to learn more about the tools and resources we can offer to help you manage risks, control workers’ compensation costs, advance safety and boost employee morale.
Let’s take a step back from risk tips to look at the concept of the role of a risk manager.
Managing risk has nothing to do with titles or capacities. It has to do with responsibilities. In large corporations the “risk manager” was the person who collected and compiled data on losses. From this information it was hoped that loss could be anticipated, warnings could be issued, and hopefully insurance would pick up the pieces.
It was assumed losses are inevitable so someone had to be assigned to categorize and account for them, hopefully to minimize them.
But minimizing loss is a trap. It is impossible to do so since no manager has a secret potion or magic wand to make loss go completely away.
It begs the question – Can Risk be managed? Should risk be tolerated or assumed in the cost to do business?
Risk management is important since it consumes three types of money:
2. Risk Control – security, health safety, environmental factors (equipment safeguards, safety
training) and preventive maintenance;
3. Risk Extraction – the involuntary penalty for unfinanced and uncontrolled risk (lost
resources, business interruption, death and injury to employees).
The first two items are budgeted and expended voluntarily. The third is always a surprise and unbudgeted. That part should be the most important part of management’s concern for risk.
Executives can intuitively see the need to manage risk even if they do not know how. Three things are universally measured in business: cost, performance, and schedule. How does one measure risk?
There are four type of knowledge required:
1. Total system operations understanding
2. All system use environments
3. Every possible risk in the system
4. Analytical integration of items 1-3.
The fourth part is impossible.
The solution begins with a role reversal. The responsibility for items 1-3 falls in line management project managers, supervisors, foremen and to an extend line employees, no matter the field of endeavor. The reversal calls for top management to recognize, execute, and oversee the process.
Change can be challenging. Line managers must move from being defenders of the system regardless of loss to being managers of all risk – which they have always been. They alone control the resources required to avoid or minimize all losses.
The risk manager, on the other hand, must change from an adversarial role (“I told you so.” “If only you had listened to me.”) to become a resource to line managers and executives, providing them with techniques, methods and capabilities to augment their loss control responsibility.
When this reversal is completed, all parties are now working to prevent loss from complimentary and affirmative positions. The process becomes a major step toward increased management effectiveness and reduction of loss due to unmanaged risk.
No one should be charged with responsibility without being given sufficient resources (authority and finances) to do the job. Only then can a business confidently identify, evaluate, rank and control the full range of risk within any system.
If you lack the resources, go to www.insureok.com and look at the Risk Appetite and Risk Strategy tabs. These two sections will get you started on your exploration of risk management ideas. Then talk to me about resources to control risk.
Risk Management Strategy
Whether you own a multi-national company, a small business, or a home -- anything you value is subject to risk. If you will take a few minutes to review your risk potential, you will have a better idea what you want to insure. After the review, a few minutes talk may be the difference between proper protection and significant loss. Each question is ranked on a 1 to 5 scale. The higher the number the more the insured AGREES with the statement presented; thus "1" indicates strong disagreement and "5" translates into strong agreement. The higher the score, the more willing the insured is to explore alternative risk financing techniques.
Each level can point to different programs:
Low (18 -30) - Traditional Insurance (First Dollar). Not ready for too much of the unexpected;
Low-to-Medium (31-45) - Leaning towards risk averse, but might want to consider a retrospective type plan for liability coupled with a high deductible property program;
Medium (46-60) - A high deductible program for casualty lines along with the same for property lines. Casualty lines would require a stop-loss provision of some type for those in this range;
Medium-to-High (61-75) - A high deductible program for all lines with no aggregate or stop loss. Essentially the amount out of pocket is unlimited with the exception of the per-occurrence deductible. A protected cell captive may also be an option;
High (76-90) - Insureds in this range may be ready for a captive without a stop loss or a fully self-insured program.
Material Fact Information or data supplied by the insured, the truth and accuracy of which the insurer relies on to make an underwriting decision. Three tests are applied when deciding if a fact is material or merely informational. A fact is material if:
·The underwriter would have made a different underwriting decision. For example, the decision was made to offer coverage, but if “X’ had been known, coverage would not have been offered;
·The underwriter would have charged a different premium. The building is located in a protection class 7, not the 4 that was reported which will result in an increase in premium when corrected.
·The underwriter would have applied different terms and conditions. Theft coverage would have been excluded had the underwriter known that the alarm was recently disconnected.
Concealment or misrepresentation of a material fact by the insured (or the agent) will generally lead to the voidance of a policy.
Concealment A lie by omission; to prevent information from being known. Improving the perception of something by withholding truth that may change a decision; if the underwriter had wanted to know, he/she would have asked. Concealment may actually be an unintentional act. The concealment of a material fact results in a policy becoming void.
Misrepresentation A dressed-up term for an overt lie. This is a knowingly false statement made in the application and depended on by the underwriter to arrive at an underwriting decision. However, this term is not equivalent to a warranty. The root of this term is “Representation” meaning that the information is true to the best of the insured’s knowledge; the information is not guaranteed - thus, it is not a warranty of accuracy (which implies absolute truth).
Fraud A false statement or act intentionally committed by one to gain advantage over or induce another to a particular action to the detriment of the second (the defrauded individual). This is a catch-all category commonly tied in with “concealment” and “misrepresentation.” The main distinction with “fraud” is that it is an outright intentional act by the defrauding party. Fraud of a “material” nature will void coverage and may also be a criminal act.
Void As if it never existed. In essence if certain acts are committed or policy provisions ignored, the insurance policy has no legal effect and is unenforceable on the insurance carrier.
Diminution of Value The difference in the fair market value of personal property (chattel) following damage and repair, and what the property would have been worth had no damage occurred. The theory is based on the market belief that personal property which has suffered damage and been repaired is worth less than similar property which has never been damaged, even when the damaged property has been restored incorporating parts of like kind and quality. Most often associated with physical damage to automobiles.
Eggshell Skull A legal term based in tort and criminal law that states that tortfeasors take the injured party as they find them. Also known as the “thin skull” rule, it states that if the injured party has a condition that predisposes them to greater injury than the normal human, the tortfeasor is not relieved of any of the costs resulting from the bodily injury just because of the condition. All injury and the costs associated with such injuries are assigned to the individual that committed the initial wrongful act, regardless of the ability to foresee the results or the fact that that the injury is made worse by a preexisting condition or predisposition to injury.
Crumbling Skull A legal theory sometimes used as a defense to or argument against application of the “Eggshell Skull” rule. The principle behind this defense is that the result would have been the same whether or not the accused wrongdoer was involved. Best exampled in medical practices: the patient was dying; the doctor attempted some radical measures to maintain life and did not succeed and in fact were the proximate cause of death. Crumbling skull principles would not hold the doctor responsible for causing a foregone conclusion. To protect the doctor, the death would have to have been certain within approximately the same time frame.
Damages Serves a dual purpose: 1) as a monetary remedy for a person, persons or entity against whom a wrong has been committed; this amount may only be a part of 2) the sum imposed on a tortfeasor for the violation of a duty owed. Combined, these are two sides of the same coin, so to speak. There must be a duty owed or created (tort, contract or statute), a breach and resulting injury. There are several types of “damages” including Compensatory, Punitive and Liquidated damages.
Compensatory Damages Payment for actual injury or economic loss. Compensatory damages are further divided into Special Damages and General Damages. Special Damages are specific and quantifiable to pay for medical costs, lost wages, repair costs and other such costs. General Damages “generally” have no basis for calculation and include pain and suffering, mental anguish or loss of reputation.
Punitive Damages Meant to punish the wrongdoer whose actions are egregious, willful, wanton or malicious. The amount is intended to warn others to avoid such actions.
Liquidated Damages A contractual agreement requiring one party to pay another a specified amount if certain contractual provisions are violated or are not completed. Liquidated damages are necessary when actual damages are difficult to calculate or estimate at the beginning of the contract.
Functional Replacement Cost Property is valued at the cost necessary to replace damaged or destroyed property with new property of unlike kind and quality. The property performs the same general function allowing the insured to accomplish their business objectives. Property replaced using functionally equivalent materials and products are less expensive and often require a shorter replacement schedule.
Comparative Negligence Each party’s relative “fault” for the accident is compared and the injured party’s (plaintiff) ultimate damages award is reduced by their percentage of culpability. For example, if the plaintiff is found to be 40 percent at fault, the $1,000 damages awarded would be reduced to $600. Three variations of the comparative fault rule are utilized: 1) pure comparative fault; 2) modified comparative fault - 50 percent bar; and 3) modified comparative fault - 51 percent bar. In each variation, the damaged party’s award is reduced by the percentage of their own contribution to the incident.
Pure Comparative Fault Allows the injured party to recover even if they are 99 percent at fault. Any award is reduced by their contribution to the injury or damage. Thirteen states apply this rule of comparative negligence: Alaska, Ariz., Calif., Fla., Ky., La., Miss., Mo., N.M., N.Y., R.I., S.D., and Wash;
Modified Comparative Fault - 50 percent Bar An injured party cannot recover if they are 50 percent or more at fault. They are able to recover if there percentage of fault falls between 0 and 49 percent. Twelve states apply this rule of comparative negligence: Ark., Colo., Ga., Idaho, Kan., Maine, Neb., N.D., Okla., Tenn., Utah, and W. Va.; and
Modified Comparative Fault - 51 percent Bar An injured party can recover from another party provided they (the injured party) are no more than 50 percent at fault. Twenty-one states apply this version of comparative negligence: Conn., Del., Hawaii, Ill., Ind., Iowa, Mass., Mich., Minn., Mont., Nev., N.H., N.J., Ohio, Ore., Pa., S.C., Texas, Vt., Wis., and Wyo.
Contributory Negligence Application of the contributory negligence common law doctrine states that if the injured person was even 1 percent culpable in causing or aggravating his own injury he is barred from any recovery from the other party. This is an absolute defense in the jurisdictions that apply this principle; some jurisdictions require the defendant (the one “most at fault”) to prove the negligence of the plaintiff (the one “most damaged”), while others require the plaintiff to disprove any negligence. Only five jurisdictions still apply pure contributory negligence: Alabama, the District of Columbia, Maryland, North Carolina and Virginia.
Constructive Total Loss The property can be repaired, but the cost to repair the damaged property is greater than the value of the property after it is repaired (it would cost more to repair it than it would be worth when done). It is more economical for the insurance carrier to pay the insured the “value” of the property (its actual cash value or replacement cost, however the policy is set up) and recover as much in salvage value as possible.
Pure Risk There are only two possibilities; something bad happening or nothing happening. It is unlikely that any measurable benefit will arise from a pure risk. The house will enjoy a year with nothing bad occurring or there will be damage caused by a covered cause of loss (fire, wind, etc.). Predicting the outcomes of a pure risk is accomplished (sometimes) using the law of large numbers, a priori data or empirical data. Pure risk, also known as absolute risk, is insurable.
Speculative Risk Three possible outcomes exist in speculative risk: something good (gain), something bad (loss) or nothing (staying even). Gambling and investing in the stock market are two examples of speculative risks. Each offers a chance to make money, lose money or walk away even. Again, do not equate gambling and investing on any other level than as both being a speculative risk. Gambling is designed to enrich one party (the house); the odds are always in its favor. Investing is designed to enrich all involved, the house that set up the investment “game” AND those that chose to place money in the game - all participants with “skin in the game” win or lose together. Speculative risk is not insurable in the traditional insurance market; there are other means to hedge speculative risk such as diversification and derivatives.
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