THE MOST MISUNDERSTOOD BUSINESS INSURANCE CONCEPTS

10. Why does my agent want to see my lease?

9. If I do have a loss, I'll need a public adjuster right away

8. All policies are the same

7. Named perils vs. open perils (formerly called "all risk")

6. I want a policy that covers everything.

5. Why does the insurance company need to know my payroll or receipts?

4. Independent Contractors

3. Coinsurance

2. Replacement Cost Coverage and Actual Cash Value

1. Insurance is a gamble. If I don't have a claim, I lose.

Wrong. Not having insurance is the gamble. Think of insurance as a manageable fixed business expense which takes the place of the possibility of unpredictable, unmanageable income disruption or expense. It facilitates reliable business planning and prediction. Without insurance, you'd have to estimate the possibilities of all sorts of negative events and set aside resources to offset their projected consequences, or take out a loan to recover. The chances of this strategy successfully overcoming a major catastrophe are slim. However, millions of businesses cooperating in such risk management is the basis of insurance. Your premiums are not kept in a shoebox; they are used to compensate other businessowners for their inevitable losses. And yes, if the insurance companies make astute loss predictions and set adequate rates, they make a fair profit for providing this service.

2. Replacement Cost Coverage and Actual Cash Value.

The cost of replacing or rebuilding as was is replacement cost coverage. It does not include the cost of improvements or betterments, even if required by building codes or laws passed since the building was built. (That can be covered by ordinance or law coverage.)

Actual Cash Value (ACV) is today's replacement cost minus depreciation (decrease in value resulting from use, obsolescence or wear and tear.) It is important to note that the starting point is today's replacement cost, not the original cost.

When insuring for replacement cost, the amount of insurance must be based on replacement cost.

example: Building replacement cost = $100,000, ACV = $77,000
replacement cost policy is based on $100,000
ACV policy is based on $77,000

money saving hint: if you're confident of the value you've decided to insure for, asking for a 90% or 100% coinsurance clause can often save 5-10%. For example, if you insure the above building for $100,000 it would usually be insured at the 80% coinsurance clause rate. However, you could also choose a 100% coinsurance clause. That rate is often 10% less (depends on the type of policy).

3. Coinsurance

If you are insuring a $100,000 item, there is not much chance of a total loss (which is why the premium is not $100,000). The insurance companies calculate the most probable loss by applying a factor (the basis of the insurance rate) to the total value. Obviously, the higher the value, the more chance of a larger loss. Therefore, the rate factor must be applied to the total value. This is the reasoning behind what is commonly called the 80% (or 90% or 100%) rate. To be valid, the rate must be applied to a specified percentage of the full value. In the event of an underinsured loss, there is a coinsurance penalty.

Here's an example:

value of building: $100,000
coinsurance clause: 80%
insurance required: $80,000
amount of loss: $10,000
deductible: $250

case 1: building insured for $83,000 - meets coinsurance requirement
claim payment: $10,000 less $250 deductible = $9,750

case 2: building insured for $60,000 - coinsurance penalty applies
formula: amount of insurance/amount required x loss
$60,000/$80,000 = .75
claim payment: $10,000 x .75 less $250 deductible = $7,250

4. Independent Contractors

You do not have the option of calling a worker an employee or an independent contractor. The work and your relation to the worker determine the proper status, not whether you choose to withhold payroll taxes. The IRS has a series of tests to distinguish between employees and independent contractors. Massachusetts has also recently changed its laws to be even more stringent.

If the worker is an employee, you must pay payroll taxes and purchase workers compensation.

5. Why does the insurance company need to know my payroll or receipts?

In general, the magnitude or scope of your business is a good indicator of the probability of loss; a larger business has a higher risk, and must pay a higher premium. Payroll, receipts, sales, area and units are the standard measures.

Liability policies are usually based on an estimate at the beginning of the policy period and subject to audit at policy expiration. This is a fair way to calculate the premium for a business whose exposures may change from year to year.

For one person businesses, payroll is usually defined as $28,600 (some companies use a different amount), regardless of actual payroll. Therefore, it is often not necessary to disclose your actual earnings.

6. I want a policy that covers everything.

Sorry, no policy covers everything. There is no substitute for carefully evaluating areas which require insurance, and being aware of policy limitations. Some risks (for example: war, wear and tear) are just not insurable. Others (flood, employment practices liability) are available but not usually included even in "package" policies. A trusted insurance agent can be a great help with making informed decisions, but the insured is ultimately responsible for proper amounts and types of coverage. More than ever, policies are readable and understandable.

Don't assume that anything is (or isn't) covered. Discuss all concerns with your agent.


7. Named perils vs. open perils (formerly called "all risk")

A named perils policy covers only the causes of loss listed on the policy (for example: fire, wind, hail). An open perils policy (often called a "special" form) covers anything that is not specifically excluded in the policy exclusions or limitations sections. Many policies include both types of coverage. For example, a commercial package will often insure the building for open perils and business personal property for named perils (also usual on homeowners policies).

8. All policies are the same.

Wrong. With the exception of a few policy forms which Massachusetts insists on writing (e.g. workers compensation, auto), policy coverages (and prices) vary widely from company to company. The trend is that these differences are increasing. It is often not even possible to get "apples to apples" comparisons. Increasingly, the businessowner must analyze competing proposals to determine areas of difference. On the other hand, these differences open the possibility of finding a policy uniquely suited to your business.

9. If I do have a loss, I'll need a public adjuster right away.

Not necessarily. Many public adjusters (who represent the insured, not the insurance company) are competent professionals who perform a valuable service, especially in complex losses. However, they charge a percentage of the settlement as their fee. If a loss is simple and the public adjuster doesn't get a larger settlement, the insured can actually end up with less. As a rule, insurance companies want prompt and fair claim settlements, and happy insureds. Hiring a public adjuster also takes your agent "out of the loop" because negotiations are between the company and the public adjuster.

10. Why does my agent want to see my lease?

Many leases require special coverages, like plate glass insurance or special language protecting the lessor. Your agent needs the lease to determine any special requirements.