Business Insurance Basics

Most businesses need to purchase at least the following four types of insurance:

1. Property Insurance

Property insurance compensates a business if the property used in the business

is lost or damaged as the result of various types of common perils, such as fire

or theft. Property insurance covers not just a building or structure but also the

contents, including office furnishings, inventory, raw materials, machinery,

computers and other items vital to a business’s operations. Depending on the

type of policy, property insurance may include coverage for equipment breakdown,

removal of debris after a fire or other destructive event, some types of

water damage and other losses.

Business Interruption Insurance

Also known as business income insurance, business interruption insurance is

a type of property insurance. A business whose property has sustained a direct

physical loss such as fire damage or a damaged roof due to a tree falling on it

in a windstorm and has to close down completely while the premises are being

repaired may lose out to competitors. A quick resumption of business after a

disaster is essential. That is why business interruption insurance is so important.

There are typically three types of business interruption insurance. A business

can purchase any one or combination of these.

• Business Income Coverage: Compensates for lost income if a company

has to vacate its premises due to disaster-related damage that is covered

under the property insurance policy. Business income insurance covers the

profits the company would have earned, based on financial records, had

the disaster not occurred. The policy also covers operating expenses, such

as electricity, that continue even though business activities have come to a

temporary halt.

• Extra Income Coverage: Reimburses the company for a reasonable sum of

money that it spends, over and above normal operating expenses, to avoid

having to shut down during the restoration period.

• Contingent Business Interruption Insurance: Protects a businessowner’s

earnings following physical loss or damage to the property of the insured’s

suppliers or customers, as opposed to its own property.

Damage due to floods, earthquakes and acts of terrorism are generally not

covered by standard business property insurance but can be purchased through

various markets.

Protection Against Flood Damage

Property insurance policies usually exclude coverage for flood damage.

Businesses should find out from their local government office or commercial

bank whether their business is located in a flood zone and whether their location

has been flooded in the past. Flood insurance is available through the federal

government’s National Flood Insurance Program (www.FloodSmart.gov),

which is serviced by private carriers, and from a few specialty insurers.

Protection Against Earthquake Damage

Coverage for earthquake damage is excluded in most property insurance policies,

including businessowners package policies. Businesses in an earthquakeprone

area will need a special earthquake insurance policy or commercial property

earthquake endorsement.

Protection Against Terrorist Attack Losses

Under the Terrorism Risk Insurance Act of 2002 and its extensions, only businesses

that purchase optional terrorism coverage are covered for losses arising

from terrorist acts. The exception is workers compensation, which covers workrelated

injuries and deaths including those due to acts of terrorism.

2. Liability Insurance

Any enterprise can be sued. Customers may claim that the business caused them

harm as the result of, for example, a defective product, an error in a service or

disregard for another person’s property. Or a claimant may allege that the business

created a hazardous environment. Liability insurance pays damages for

which the business is found liable, up to the policy limits, as well as attorneys’

fees and other legal defense expenses. It also pays the medical bills of any people

injured by, or on the premises of, the business.

A Commercial General Liability (CGL) insurance policy is the first line of

defense against many common claims. CGL policies cover claims in four basic

categories of business liability:

• Bodily injury

• Property damage

• Personal injury (including slander or libel)

• Advertising injury (damage from slander or false advertising)

In addition to covering claims listed above, CGL policies also cover the cost of

defending or settling claims. General liability insurance policies always state the

maximum amount that the insurer will pay during the policy period.

There are two major forms of liability insurance policies a business can select:

occurrence and claims made. Both types of policies have their advantages.

• Occurrence Policy: An occurrence policy covers a business for harm to

others caused by incidents that occurred while a policy is in force, no

matter when the claim is filed. For example, a person might sue a business

in 2010 for an injury stemming from a fall in 1999. The policy that was in

place when the incident occurred (i.e. 1999) will apply, even if the company

now has a policy in place with higher limits. Occurrence coverage may not

be available in some states or for some industries or professions.

• Claims Made Policy: A claims made policy covers the business based on

the policy that is in force when the claim is made, regardless of when the

incident occurred. In the above example, the limits in the policy in effect

in 2010 would apply. Businesses with claims made policies can purchase

optional “tail coverage.” Tail coverage enables a business to report claims

after the policy has ended for alleged injuries that occurred while the policy

was in effect.

3. Commercial Vehicle Insurance

A commercial auto policy provides coverage for vehicles that are used primarily

in connection with commercial establishments or business activities. The

insurance pays any costs to third parties resulting from bodily injury or property

damage for which the business is legally liable up to the policy limits.

While the major coverages are the same, commercial auto policies differs

from a personal auto policy in a number of technical respects. They may have

higher limits and/or provisions that cover rented and other non-owned vehicles,

including employees’ cars driven for company business. Several insurers offer

business auto policies geared to owners of small businesses or specific types of

businesses.

4. Workers Compensation Insurance

Employers have a legal responsibility to their employees to make the workplace

safe. However, despite precautions, accidents can occur. To protect employers

from lawsuits resulting from workplace accidents and to provide medical care

and compensation for lost income to employees hurt in workplace accidents,

in almost every state businesses are required by law to buy workers compensation

insurance. Workers compensation insurance covers workers injured on the

job, whether they are hurt on the workplace premises or elsewhere, or in auto

accidents while on business. It also covers work-related illnesses. Workers com-

pensation provides payments to injured workers, without regard to who was at

fault in the accident, for time lost from work and for medical and rehabilitation

services. It also provides death benefits to surviving spouses and dependents.

Each state has different laws governing the amount and duration of lost income

benefits, the provision of medical and rehabilitation services and how the system

is administered. For example, in most states there are regulations that cover

whether the worker or employer can choose the doctor who treats the injuries

and how disputes about benefits are resolved.

Workers compensation insurance must be bought as a separate policy.

In-home business and businessowners policies (BOPs) are sold as package policies

but do not include coverage for workers’ injuries.

Other Types of Business Coverages

The first four coverages discussed below are different types of liability insurance

policies available to businesses. The fifth is a form of life insurance. There are

also specialized liability policies geared to specific types of businesses.

1. Errors and Omissions Insurance/Professional Liability

Some businesses involve services such as giving advice, making recommendations,

designing things, providing physical care or representing the needs of

others, which can lead to being sued by customers, clients or patients claiming

that the business’ failure to perform a job properly has injured them. Errors and

omissions or professional liability insurance covers these situations. The policy

will pay any judgment for which the insured is legally liable, up to the policy

limit. It also provides legal defense costs, even when there has been no wrongdoing.

2. Employment Practices Liability Insurance

Employment practices liability insurance covers, up to the policy limits, damages

for which an employer is legally liable such as violating an employee’s civil

or other legal rights. In addition to paying a judgment for which the insured is

liable, it also provides legal defense costs, which can be substantial even when

there has been no wrongdoing.

3. Directors and Officers Liability Insurance

Directors and officers liability insurance protects directors and officers of corporations

or nonprofit organizations if there is a lawsuit claiming they managed

the business or organization without proper regard for the rights of others. The

policy will pay any judgment for which the insured is legally liable, up to the

policy limit. It also provides for legal defense costs, even where there has been

no wrongdoing.

4. Umbrella or Excess Policies

As the name implies, an umbrella liability policy provides coverage over and

above a business’s other liability coverages. It is designed to protect against

unusually high losses, providing protection when the policy limits of one of the

underlying policies have been used up. For a typical business, an umbrella policy

would provide protection beyond Its general liability and auto liability policies.

If a company has employment practices liability insurance, directors and

officers liability, or other types of liability insurance, the umbrella could provide

protection beyond those policy limits as well. Cost depends on the nature of the

business, its size, the type of risks the business faces and the ways the business

implements risk reduction.

5. Key Person Life Insurance

The loss of a key person can be a major blow to a small business if that person

is the founder of the business or is the key contact for customers and suppliers

and the management of the business. Loss of the key person may also make the

running of the business less efficient and result in a loss of capital. Losses caused

by the death of a key employee are insurable. Such policies compensate the

business against significant losses that result from that person’s death or disability.

The amount and cost of insurance needed for a particular business depends

on the situation and the age, health and role of the key employee. Key employee

life insurance pays a death benefit to the company when the key employee

dies. The policy is normally owned by the company, which pays the premiums

and is the beneficiary. The monies from key person insurance can be used to

buy back shares in a company from the estate of the deceased, pay a head hunting

firm to find a suitable replacement and cover costs or expenses while the

business adjusts to the loss.

Package Policies

Commercial insurers sell coverages separately and/or offer policies that combine

protection from most major property and liability risks in one package. Package

policies are created for types of businesses that generally face the same kind and

degree of risk.

1. Packages for Small Businesses

Smaller companies often purchase a package policy known as the Business-

owners Policy, or BOP. A BOP is recommended for most small businesses (usually

100 employees or less), as it is often the most affordable way to obtain broad

coverage. BOPs are “off the shelf” policies combining many of the basic coverages

needed by a typical small business into a standard package at a premium that

is generally less than would be required to purchase these coverages separately.

Combining both property and liability insurance, a BOP will cover a business in

the event of property damage, suspended operations, lawsuits resulting from

bodily injury or property damage to others, etc. BOPs do not cover professional

liability, auto insurance, workers compensation or health and disability insurance.

Small businesses will need separate insurance policies to cover professional

services, vehicles and employees.

2. Commercial Multiple Peril Policies

Larger companies might purchase a commercial package policy or customize

their policies to meet the special risks they face. Commercial multiple peril policies,

often purchased by corporations, bundle property, boiler and machinery,

crime and general liability coverage together. Larger firms employee a risk manager

to help determine the company’s exposure to certain risks.

3. In-Home Business Policies

There are several insurance options designed to address the special needs of

home businesses.

• Homeowners Policy Endorsement: Homeowners may be able to add a

simple endorsement or rider to their existing homeowners policy to increase

coverage.

• In-Home Business Policy: An in-home business policy provides more

comprehensive coverage for business equipment and liability than a

homeowners policy endorsement. Many insurance companies offer

insurance policies specifically tailored to small business.

Homeowners Insurance Basics

Homeowners insurance provides financial protection against disasters. It is a package

policy, which means that it covers both damage to property and liability, or

legal responsibility, for any injuries and property damage policyholders or their

families cause to other people. This includes damage caused by household pets.

Damage caused by most disasters is covered but there are exceptions. Standard

homeowners policies do not cover flooding, earthquakes or poor maintenance.

Flood coverage, however, is available in the form of a separate policy both from

the National Flood Insurance Program (NFIP) and from a few private insurers.

Earthquake coverage is available either in the form of an endorsement or

as a separate policy. Most maintenance-related problems are the homeowners’

responsibility.

A standard homeowners insurance policy includes four essential types of

coverage. They include:

1. Coverage for the Structure of the Home

This part of a policy pays to repair or rebuild a home if it is damaged or

destroyed by fire, hurricane, hail, lightning or other disaster listed in the policy.

It will not pay for damage caused by a flood, earthquake or routine wear and

tear. Most standard policies also cover structures that are not attached to a

house such as a garage, tool shed or gazebo. Generally, these structures are covered

for about 10 percent of the total amount of insurance on the structure of

the home.

2. Coverage for Personal Belongings

Furniture, clothes, sports equipment and other personal items are covered if

they are stolen or destroyed by fire, hurricane or other insured disaster. Most

companies provide coverage for 50 to 70 percent of the amount of insurance on

the structure of a home. This part of the policy includes off-premises coverage.

This means that belongings are covered anywhere in the world, unless the policyholder

has decided against off-premises coverage. Expensive items like jewelry,

furs and silverware are covered, but there are usually dollar limits if they are stolen.

To insure these items to their full value, individuals can purchase a special

personal property endorsement or floater and insure the item for its appraised

value.

Trees, plants and shrubs are also covered under standard homeowners insurance—

generally up to about $500 per item. Perils covered are theft, fire, lightning,

explosion, vandalism, riot and even falling aircraft. They are not covered

for damage by wind or disease.

3. Liability Protection

Liability coverage protects against the cost of lawsuits for bodily injury or property

damage that policyholders or family members cause to other people. It also

pays for damage caused by pets. The liability portion of the policy pays for both

the cost of defending the policyholder in court and any court awards—up to the

limit of the policy. Coverage is not just in the home but extends to anywhere

in the world. Liability limits generally start at about $100,000. However, experts

recommend that homeowners purchase at least $300,000 worth of protection.

An umbrella or excess liability policy, which provides broader coverage, including

claims for libel and slander, as well as higher liability limits, can be added to

the policy. Generally, umbrella policies cost between $200 to $350 for $1 million

of additional liability protection.

Homeowners policies also provide no-fault medical coverage. In the event

that someone is injured in a policyholder’s home, the injured person can simply

submit medical bills to the policyholder’s insurance company. In this way

expenses are paid without a liability claim being filed. This coverage, however,

does not pay the medical bills for the policyholder’s own family or pets.

4. Additional Living Expenses

This pays the additional costs of living away from home if a house is inhabitable

due to damage from a fire, storm or other insured disaster. It covers hotel

bills, restaurant meals and other extra living expenses incurred while the home

is being rebuilt. Coverage for additional living expenses differs from company to

company. Many policies provide coverage for about 20 percent of the insurance

on a house. The coverage can be increased for an additional premium. Some

companies sell a policy that provides an unlimited amount of loss-of-use coverage,

but for a limited amount of time.

Additional living expense coverage also reimburses homeowners who rent

out part of their home for the rent that would have been collected from a tenant

if the home had not been destroyed.

Types of Homeowners Insurance Policies

There are several types of homeowners insurance policies that differ in the amount

of insurance coverage they provide. The different types are fairly standard throughout

the country. However, individual states and companies may offer policies that

are slightly different or go by other names such as “standard” or “deluxe.” People

who rent the homes they live in have specific renters policies.

The various types of homeowners insurance policies are listed below.

• HO-3: This is the most common policy and protects the home from all

perils except those specifically excluded.

• HO-1: Limited coverage policy

This “bare bones” policy provides coverage against the first 10 disasters. It is

no longer available in most states.

• HO-2: Basic policy

A basic policy provides protection against all 16 disasters. There is a version

of HO-2 designed for mobile homes.

• HO-8: Older home

Designed for older homes, this policy usually reimburses for damage on an

actual cash value basis, which means replacement cost less depreciation. Full

replacement cost policies may not be available for some older homes.

• HO4: Renter

Created specifically for people who rent the home they live in, this policy

protects personal possessions and any parts of the apartment that the

policyholder owns, such as newly installed kitchen cabinets, against all 16

disasters.

• H0-6: Condo/Co-op

A policy for people who own a condo or co-op, it provides coverage for

belongings and the structural parts of the building that they own. It protects

against all 16 disasters.

What Type of Disasters Are Covered?

Most homeowners policies cover the 16 disasters listed below. Some “bare bones”

policies only cover the first 10:

• Fire or lightning

• Windstorm or hail

• Explosion

• Riot or civil commotion

• Damage caused by aircraft

• Damage caused by vehicles

• Smoke

• Vandalism or malicious mischief

• Theft

• Volcanic eruption

• Falling object

• Weight of ice, snow or sleet

• Accidental discharge or overflow of water or steam from within a plumbing,

heating, air conditioning, or automatic fire-protective sprinkler system, or

from a household appliance

• Sudden and accidental tearing apart, cracking, burning, or bulging of a

steam or hot water heating system, an air conditioning or automatic fireprotective

system

• Freezing of a plumbing, heating, air conditioning or automatic, fireprotective

sprinkler system, or of a household appliance

• Sudden and accidental damage from artificially generated electrical current

(does not include loss to a tube, transistor or similar electronic component)

Standard Homeowners Policy Exclusions

Standard homeowners policies exclude coverage for flood, earthquake, war,

nuclear accident, landslide, mudslide, sinkhole. Some of these exclusions are

discussed below.

1. Floods

Flood damage is excluded under standard homeowners and renters insurance policies.

Flood coverage, however, is available in the form of a separate policy both

from the National Flood Insurance Program (NFIP) and from a few private insurers.

Additional information on flood insurance can be found on the FloodSmart.gov

Web site or by calling 888-379-9531. For coverage over and above the $250,000

limit for property and $100,000 for contents provided by the NFIP, excess flood

insurance is available from private insurance companies. (See Topic on Flood

Insurance on page 47 for further information.)

Tsunamis cause flood damage and are therefore only covered by a flood policy.

2. Earthquakes

Earthquake coverage can be a separate policy or an endorsement to a homeowners

or renters policy. It is available from most insurance companies. In

Insurance Basics

Homeowners Insurance

I.I.I. Insurance Handbook www.iii.org/insurancehandbook 9

California, it is also available from the California Earthquake Authority, a privately

funded, publically managed organization. In earthquake prone states like

California, the policy comes with a high deductible.

3. Damage Resulting from “Faulty, Defective or Inadequate” Maintenance,

Workmanship, Construction or Materials

Defective products can include construction materials. An insurance policy will

not cover damage due to lack of maintenance, mold, termite infestation and

infestation from other pests. It is the policyholder’s responsibility to take reasonable

precautions to protect the home from damage.

Levels of Coverage

There are three coverage options.

1. Actual Cash Value

This type of coverage pays to replace the home or possessions minus a deduction

for depreciation.

2. Replacement Cost

This type of coverage pays the cost of rebuilding or repairing the home or

replacing possessions without a deduction for depreciation.

3. Guaranteed/Extended Replacement Cost

An extended replacement cost policy pays a certain percentage, generally 20-25

percent, over the coverage limit to rebuild the home in the event that materials

and labor costs are pushed up by a widespread disaster, for example. For example,

if homeowners take out a policy for $100,000, they can get up to an extra

$20,000 or $25,000 of coverage.

Auto Insurance Basics

Auto insurance protects against financial loss in the event of an accident. It is a

contract between the policyholder and the insurance company. The policyholder

agrees to pay the premium and the insurance company agrees to pay losses as

defined in the policy.

Auto insurance provides property, liability and medical coverage:

 Property coverage pays for damage to, or theft of, the car.

 Liability coverage pays for the policyholder’s legal responsibility to

others for bodily injury or property damage.

 Medical coverage pays for the cost of treating injuries, rehabilitation

and sometimes lost wages and funeral expenses.

Most states require drivers to have auto liability insurance before they can legally

drive a car. (Liability insurance pays the other driver’s medical, car repair and

other costs when the policyholder is at fault in an auto accident.) All states have

laws that set the minimum amounts of insurance or other financial security

drivers have to pay for the harm caused by their negligence behind the wheel if

an accident occurs. Most auto policies are for six months to a year. A basic auto

insurance policy is comprised of six different kinds of coverage, each of which is

priced separately (see below).

1. Bodily Injury Liability

This coverage applies to injuries that the policyholder and family members listed

on the policy cause to someone else. These individuals are also covered when

driving other peoples’ cars with permission. As motorists in serious accidents

may be sued for large amounts, drivers can opt to buy more than the staterequired

minimum to protect personal assets such as homes and savings.

2. Medical Payments or Personal Injury Protection (PIP)

This coverage pays for the treatment of injuries to the driver and passengers

of the policyholder’s car. At its broadest, PIP can cover medical payments,

lost wages and the cost of replacing services normally performed by someone

injured in an auto accident. It may also cover funeral costs.

3. Property Damage Liability

This coverage pays for damage policyholders (or someone driving the car with

their permission) may cause to someone else’s property. Usually, this means

damage to someone else’s car, but it also includes damage to lamp posts, telephone

poles, fences, buildings or other structures hit in an accident.

4. Collision

This coverage pays for damage to the policyholder’s car resulting from a collision

with another car, an object or as a result of flipping over. It also covers

damage caused by potholes. Collision coverage is generally sold with a deductible

of $250 to $1,000—the higher the deductible, the lower the premium. Even

if policyholders are at fault for an accident, collision coverage will reimburse

them for the costs of repairing the car, minus the deductible. If the policyholder

is not at fault, the insurance company may try to recover the amount it paid

from the other driver’s insurance company, a process known as subrogation. If

the company is successful, policyholders will also be reimbursed for the deductible.

5. Comprehensive

This coverage reimburses for loss due to theft or damage caused by something

other than a collision with another car or object, such as fire, falling objects,

missiles, explosions, earthquakes, windstorms, hail, flood, vandalism and riots,

or contact with animals such as birds or deer. Comprehensive insurance is usually

sold with a $100 to $300 deductible, though policyholders may opt for a

higher deductible as a way of lowering their premium. Comprehensive insurance

may also reimburse the policyholder if a windshield is cracked or shattered.

Some companies offer separate glass coverage with or without a deductible.

States do not require the purchase of collision or comprehensive coverage, but

lenders may insist borrowers carry it until a car loan is paid off. It may also be a

requirement of some dealerships if a car is leased.

Overview

The insurance industry safeguards the assets of its policyholders by transferring

risk from an individual or business to an insurance company. Insurance companies

act as financial intermediaries in that they invest the premiums they collect

for providing this service. Insurance company size is usually measured by net

premiums written, that is, premium revenues less amounts paid for reinsurance.

There are three main insurance sectors: property/casualty, life/health and health

insurance. Property/casualty (P/C) consists mainly of auto, home and commercial

insurance. Life/health (L/H) consists mainly of life insurance and annuity

products. Health insurance is offered by private health insurance companies

and some L/H and P/C insurers, as well as by government programs such as

Medicare.

Regulation

All types of insurance are regulated by the states, with each state having its

own set of statutes and rules. State insurance departments oversee insurer solvency,

market conduct and, to a greater or lesser degree, review and rule on

requests for rate increases for coverage. The National Association of Insurance

Commissioners develops model rules and regulations for the industry, many

of which must be approved by state legislatures. The McCarran-Ferguson Act,

passed by Congress in 1945, refers to continued state regulation of the insurance

industry as being in the public interest. Under the 1999 Gramm-Leach-Bliley

Financial Services Modernization Act, insurance activities—whether conducted

by banks, broker-dealers or insurers—are regulated by the states. However, there

have been, and continue to be, challenges to state regulation from some segments

of the federal government as well as from some financial services firms.

Accounting

Insurers are required to use statutory accounting principles (SAP) when filing

annual financial reports with state regulators and the Internal Revenue Service. SAP,

which evolved to enhance the industry’s financial stability, is more conservative

than the generally accepted accounting principles (GAAP), established by the independent

Financial Accounting Standards Board (FASB). The Securities and Exchange

Commission (SEC) requires publicly owned companies to report their financial

results using GAAP rules. Insurers outside the United States use standards that differ

from SAP and GAAP. As global markets developed, the need for more uniform

accounting standards became clear. In 2001 the International Accounting Standards

Board (IASB), an independent international accounting standards setting organization,

began work on a set of standards, called International Financial Reporting

Standards (IFRS) that it hopes will be used around the world. Since 2001 over 100

countries have required or permitted the use of IFRS.

In 2007 the SEC voted to stop requiring non-U.S. companies that use IFRS

to re-issue their financial reports for U.S. investors using GAAP. In 2008 the

National Association of Insurance Commissioners began to explore ways to

move from statutory accounting principles to IFRS. Also in 2008, the FASB and

IASB undertook a joint project to develop a common and improved framework

for financial reporting.