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October 10, 2019 Articles

A Guide to Counseling Small Business Owners on Insurance Procurement and Coverage

Following these simple tips when counseling a small business owner before a loss can make a significant difference in that business’s success.

By Shavon J. Smith[1]

While small business owners frequently outsource many functions, they are the ultimate decision makers tasked with managing their business’s risk and evaluating the scope of coverage necessary to potentially offset those risks. Because of the myriad decisions small business owners must make, questions related to insurance procurement and coverage often receive scant to little inquiry. Generally, barring situations where a small business owner is a medical professional, architect, engineer, or other professional, new business owners frequently need to be reminded to add risk management and insurance procurement to the list of “must do” tasks before launching. Even when insurance is on the “must do” list, however, small business owners are usually concerned with costs and often procure just enough coverage to satisfy contractual requirements; such insurance is rarely carefully curated to the business’s risks.

The failure to properly tailor insurance coverage to a small business’s risk could be disastrous, given that problems for small business owners tend to hit harder than problems for large corporations. For example, a $20,000 uninsured theft by an employee could mean having to lay off other employees. Similarly, failing to procure sufficient general liability coverage could result in bankruptcy. Despite the potentially disastrous consequences of being uninsured or underinsured for certain risks, many small business owners make critical mistakes when managing their risk or procuring insurance. This article provides a summary of common types of insurance coverage required by small businesses and identifies common mistakes made by small businesses concerning insurance procurement and coverage.

What Is Considered a Small Business?

The term “small” presents a huge range of possibilities when it comes to defining “small business.” To qualify as a small business under the guidelines of the Small Business Administration (SBA), the business must be organized for profit, “independently owned and operated,” and “not be nationally dominant in its field.”[2]

To determine whether a business entity qualifies as a small business within a particular industry, the SBA uses a numerical measurement called the “size standard.”[3] The size standards consider either the number of people employed by the business or the total income of the business among different industries. The size standard is not uniform across industries, however, and the maximum number of employees and total income necessary to qualify as a small business entity vary significantly.[4] A small business can have one employee or over a thousand employees and revenue ranging from $50,000 to $30 million. For example, the SBA may consider a toy manufacturer with fewer than 500 employees to be a small business and also consider a manufacturer of residential light fixtures with over 700 employees to be a small business.

In contrast, some insurance companies consider a business that makes less than a few million dollars with 50 or fewer employees to be a small business for purposes of evaluating available coverages.[5]

What Types of Insurance Should a Small Business Have?

All businesses—small or large—require some form of insurance. Larger businesses with thousands of employees and higher revenues usually hire a risk management consultant or have a risk management department to evaluate specific business risks and necessary insurance coverage to avoid large financial losses.

While smaller businesses do not necessarily encounter the same level of potential financial loss as their larger counterparts, risk management is of equal importance. Depending on the nature of the business, the location, and the number of employees, small businesses encounter a large array of issues that could lead to financial ruin or shutter them altogether—often for risks outside of the business owner’s control.

Some of the common risks small businesses face include damage to property, inventory, or equipment; business interruption; liability for injuries or damage to third parties; supply chain interruptions; loss of key employees; wrongful employment practices; workers’ compensation and employer’s liability claims; and environmental losses.[6] Generally, at a minimum, most small businesses need to purchase property insurance, commercial general liability insurance, business vehicle insurance, and workers’ compensation and employer’s liability insurance to cover more common risks.[7]

Property insurance. Property insurance covers common issues that affect the property a business owner uses to operate the business. For instance, a commercial property policy will generally provide coverage for damage to a commercial building or business personal property caused by a covered cause of loss, such as fire or similar perils. Some commercial property policies also provide business interruption coverage for loss of business income during defined periods if caused by covered perils. It is critical that small business owners review and understand the scope of coverage afforded by their commercial property policies to evaluate whether all of their potential risks—including business interruption—are covered and under what circumstances.

General liability insurance. Unlike property insurance, general liability insurance protects business owners from claims and lawsuits arising out of injuries to third persons allegedly caused by the business’s work, products, or employee’s acts or omissions. Notably, however, commercial liability policies are not performance bonds and usually exclude coverage for damage to the business’s work or product itself. In addition, many commercial general liability policies exclude coverage for certain risks, such as liability arising out of vehicles used in the business or workers’ compensation and employer’s liability claims, necessitating the purchase of additional insurance policies to protect against those risks.

Automobile liability insurance. Coverage for business vehicles, generally procured through commercial automobile policies, protects small businesses from liability arising out of any vehicles used during the operation of the small business. Such coverage is critical because many general liability policies exclude coverage for liabilities arising out of the use, ownership, or maintenance of automobiles. Moreover, if a vehicle is used for both business and personal matters, it is important to note that personal auto insurance policies do not cover accidents if the vehicle is used mainly for business purposes.

Workers’ compensation and employer’s liability insurance. In addition, because general liability policies typically exclude coverage for injuries to employees or claims that are otherwise protected by workers’ compensation statutes, small businesses with employees are well advised to procure workers’ compensation and employer’s liability policies to insure against employee liability claims. All states except Texas require businesses to purchase workers’ compensation insurance if the business employs a certain number of individuals.[8]

Business owner policies. In addition to the foregoing coverages, some insurance companies offer business owners the opportunity to purchase several types of insurance in a single package called “business owner policies.”[9] A business owner policy, or BOP, combines general liability insurance with commercial property insurance and business interruption insurance, typically at a lower rate than if the policies were purchased separately. BOPs are typically more suited to small businesses with low risk, fewer than 100 employees, revenues of less than $5 million, and operating out of a small commercial space.[10] The attractiveness of a BOP to a small business owner is that it generally covers all of the needs of a brick-and-mortar small business under one policy.

BOPs, however, may not necessarily cover all risks that a small business may face. For instance, BOPs typically do not cover employee discrimination lawsuits. One study revealed that nearly one in five small businesses will face employee discrimination litigation and, of the cases that go to trial, 25 percent result in judgments exceeding a half million dollars.[11]

The  nature of the business, number of individuals employed, and the location of the business are all factors that determine the type of insurance that a small business should purchase. Take, for example, a small business owner who sells scented candles at a farmers’ market in California and operates out of her garage with one employee. That small business owner likely needs to purchase only product liability, automobile liability, and property insurance. If the business expands and she hires more employees, she would likely have to purchase workers’ compensation and employer’s liability insurance. Alternatively, a flower shop that employs 50 people and owns delivery vehicles would need to purchase property, liability, workers’ compensation and employer’s liability coverage, and commercial automobile insurance. If either offered employee benefits, the business owner may want to consider purchasing employers benefit  coverage. While both businesses are considered to be small businesses, the type of insurance plans they need to cover all of the risks associated with their respective businesses is based on the nature of the business, number of employees, and location.

Common Insurance Mistakes Small Business Owners Make

Underinsured or improperly insured risk can portend the end of a small business. Here are some of the common mistakes small business owners make concerning both the procurement of insurance coverage and the use of insurance:

1. Thinking they do not need insurance. While it is obvious to some small business owners that they need insurance, other small, home-based businesses generally overlook insurance altogether. With no employees or commercial space, a home-based business owner may feel that his or her risks are low or even mistakenly believe that his or her homeowner’s insurance, without purchasing a business rider, provides sufficient coverage. While the risk and liability for a small, home-based business is certainly limited, the business still faces significant risk with respect to data , inventory loss, or intellectual property infringement. Many insurers offer general liability and professional liability policies specifically for home-based businesses that cover those risks.

2. Failing to use a broker. Starting a business is a time for courageous optimism, and there is a certain mind-set entrepreneurs have to adopt to be successful. Often, thinking through everything that potentially could go wrong is not on the “must do” list and, indeed, may seem counterproductive to a small business owner. Enter the importance of an insurance broker. While large companies may have a risk-management division, the insurance broker can function like a risk management department for the small business owner. Insurance brokers who work with small business owners not only regularly assist in assessing coverage needs but will also identify methods of mitigating risks the small business owner may not have considered.

3. Not fully understanding the risks the small business faces. A small business owner cannot be certain to select the proper insurance when he or she does not know the risks the business will face. While small business owners likely have a keen understanding of risks that are obvious and directly related to what they do, they may not appreciate the full panoply of risks related to operating the business. For instance, a small electrical company likely is aware of possible damage that can be caused to a customer’s home, the risk of an employee getting hurt on the job, or the possibility of getting into a vehicular accident on the way to a job site. That same owner, however, may not anticipate that customers’ personal information, including addresses and credit card information, is at risk. According to one study conducted in 2018, 58 percent of small to midsized businesses experienced a cyberattack during the prior year.[12] Often, hackers target small businesses to access bigger businesses on the assumption that small businesses have fewer cyber protections. For instance, Target Corporation faced a significant breach of customer data in 2013, with access likely being gained through one of its heating, ventilation, and air conditioning vendors.[13]

4. Carelessly buying cyber coverage. Cybersecurity coverage can vary greatly, so small businesses need to be keenly aware of their specific risks based on how they maintain electronic data. Understanding the scope of the risk is why consultation with an insurance broker is so crucial. Small business owners should be encouraged not to blindly purchase insurance without speaking to an insurance broker who can fully assess risks, as opposed to an insurance agent who may be captive to a particular insurance company and selling one specific insurance product.

5. Failing to update their policy and notify the insurance company of changes. As with many other aspects of managing a small business, insurance policies—like marketing plans, employee handbooks, and the like—may be initially procured and then forgotten. When renewing an insurance policy, it is not uncommon for small business owners to neglect to inform their insurers about an increase in the number of employees. Further, the business owner may enter into contracts that require increased limits, yet fail to actually procure increased limits. The risk to a small business owner may also change slightly. For instance, a fitness studio may offer outdoor classes during the summer but fail to update its insurance coverage for services provided off premises. It is imperative that business owners regularly reevaluate their risk and update their coverages.

6. Not knowing whether, when, and how to provide notice to the insurance company of a potential claim. Not knowing what is covered means small business owners often do not know when to give notice of a claim to their insurers. Just by way of example, small businesses often rely solely on social media platforms for advertising because it is a free (or inexpensive) way to brand and market their products or services. The need to constantly put new content on social media may lead small businesses to inadvertently add copyrighted music or images to their social media pages. Using copyrighted music or images may lead, in turn, to receipt of a demand letter several months later asking the business owner to take down the copyrighted material and to pay hundreds, if not thousands, of dollars in damages. In addition to not fully appreciating the risk with respect to unauthorized use of intellectual property, many small business owners may not realize that their general liability or BOP policies cover claims of intellectual property infringement. Thus, small business owners may attempt to negotiate and resolve the claim themselves, as opposed to putting their insurance company on notice of what may be a covered claim. For this reason, it is imperative to counsel small businesses to annually review and understand the scope of insurance coverage procured and available to them.

Independent of not understanding what may be covered, small business owners also struggle with whether they should notify their insurers of a claim in the first instance. Often, small businesses do not fully understand what may qualify as a covered loss or claim. In addition to not knowing if an event warrants notice, business owners may prefer to let the issue “play out” before providing notice, hoping the problem will go away. Unfortunately, such an ill-advised strategy could lead to a late notice issue that could vitiate coverage, particularly if the applicable policy provides claims-made coverage. Also of concern, small business owners may worry about increased premiums or risk of insurance cancellation if they report a claim, causing them to delay or avoid notifying their insurance companies.

Finally, small business owners may not know how to notify their insurance company about a claim. Although most policies typically provide very clear methods of notice, many small business owners feel more comfortable consulting with their insurance agent or broker, and many assume that notice to an insurance agent or broker constitutes notice to the actual insurer. Small business owners should be counseled to ensure that, if used, the insurance broker provides actual notice to the insurance company and that the small business owners keep records of notice and communications with the insurance company concerning the claim.

7. Knowing when to engage insurance coverage counsel. A delayed response, coverage denial, or a reservation of rights on coverage from an insurer may feel like the final word on the subject for a small business owner. The business owner may also not appreciate that a conflict of interest may exist between his or her position and that of the insurance company, which could affect the selection of defense counsel in a liability claim. A business owner may also suspect that available limits will not cover the claim without fully understanding how policy aggregates apply.

Small business owners should know at what point to engage coverage counsel. Although that point may not be intuitive for small business owners, engaging counsel could be the difference between their claim being covered or their being left to pay the loss on their own. Consequently, when assisting small business owners, counsel should discuss the possibility of potential claims and how to report and manage those claims, should they occur.

How Counsel Can Help Their Small Business Clients

For new  and even experienced small business owners, determining the external and internal risks of the business can be extremely difficult, but failing to identify those risks can pose serious complications down the road. Attorneys representing small businesses should keep the following in mind:

1. Do not assume the owner knows what insurance is necessary. You may have to spend time discussing possible risks and helping the business owner appreciate his or her exposure.
2. Connect small business owners with an insurance broker who specializes in working with small business owners in their industry.
3. Have yearly conversations to asses risk and possible additional coverage that may be needed. You should also be sure to have that conversation with the right employee—the owner may not be the best person to assess risk or the only person who needs to be aware of potential risk.
4. Understand the client’s business, product, and business model, and suggest ways to mitigate risk and loss.

Many small business owners leave insurance on the back burner. Having the correct insurance coverage, however, is critical and may determine the business’s ultimate success or failure. The type of insurance policy that a small business owner needs should be based on the nature of the business, number of employees, and location. Some small business owners may mistakenly believe they do not need insurance or, alternatively, may not know the extent and seriousness of all the risks associated with their business. For this reason, small business owners should be counseled to contact a professional, such as an insurance broker, to fully appreciate the risks. Small business owners should also be counseled about when to update their insurance policies and when to contact insurance coverage attorneys concerning potential losses.

Procuring and maintaining the right insurance coverage should not be an intimidating or difficult process, and following these simple tips when counseling a small business owner before a loss can make a significant difference in that business’s success.

[1]     Shavon J. Smith is the founder of the SJS Law Firm, PLLC, in Washington, D.C.

[2]     U.S. Small Bus. Admin., Size Standards.

[3]     U.S. Small Bus. Admin., Size Standards.

[4]     U.S. Small Bus. Admin., Size Standards.

[5]     See, e.g., Ins. Info. Inst., Finding Coverage That Matches Your Business Size.

[6]     Terri A. Kamoto, “Top 9 Risks Facing Small Businesses,” Fin. Safety Net, June 4, 2013.

[7]     Ins. Info. Inst., Insuring Your Business: Small Business Owners’ Guide to Insurance.

[8]     Ins. Info. Inst., Insuring Your Business: Small Business Owners’ Guide to Insurance.

[9]     Ins. Info. Inst., Understanding Business Owners Policies (BOPS).

[10]   Ins. Info. Inst., Understanding Business Owners Policies (BOPS).

[11]   The 2015 Hiscox Guide to Employee Lawsuits, Employee Charge Trends Across the United States (2015).

[12]   Ivy Walker, “Cybercriminals Have Your Business in Their Crosshairs and Your Employees Are in Cahoots with Them,” Forbes, Jan. 31, 2019.

[13]   Gregory Wallace, “HVAC Vendor Eyed as Entry Point for Target Breach,” CNN Bus., Feb. 7, 2014.

    Copyright © 2019, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).