Running a small business means exposing yourself to a certain amount of risk. You need safeguards in place to handle the fallout should problems occur. Although some pitfalls and challenges can’t be avoided, they can be mitigated with the proper precautions, planning and insurance coverage. Below, insurance and legal experts detail today’s biggest insurance risks for business owners and what you can do to protect yourself against them.
What is insurance risk?
Insurance risk refers to the possibility of something going wrong that would expose your business – or the insurer – to financial damages. Business risk and insurance risk often overlap. By fully understanding the different types of business risk, you can better understand insurance risk and thus how insurance can protect your business from serious problems.
Here are the four main categories of risk to consider:
- Operational: Operational risk addresses your business’s day-to-day dealings, including handling equipment, workers, customers and your overall product or service. By insuring tangible assets like equipment and property, you can mitigate risk, and by protecting your business operations from outside events, like natural disasters, you’ll be covered.
- Strategy: Strategic risk occurs when your business’s strategy is diluted or usurped by yourself or other companies. When running a small business, you have to develop a specific strategy for your product or service and stick to it. If competitors undermine your strategy by outperforming your product or service or undercutting your prices, you run the risk of falling behind in your industry. It’s critical to research your competitors and understand how you can better protect your business’s strategic assets, like your intellectual property.
- Compliance: Compliance risk pertains to your business’s ability to adhere to certain rules and regulations outlined by your industry or the government. This includes things like tax burdens, municipal zoning and property laws, distribution laws and other rules and regulations related to your business – such as HIPAA or good manufacturing practices. Eliminating compliance risk requires that you stay abreast of the latest rules in your sector. While you can’t purchase insurance related to taxes and other forms of compliance risk, you should be aware of your obligations by understanding how your business could be at fault.
- Reputational: The final type of risk is reputational. That means protecting your business from security problems, data privacy breaches and other cybersecurity issues. It also involves taking steps to protect your brand and logo. You can insure your business and customer data in the event either is compromised, you are covered.
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What are the biggest types of insurance risk?
The biggest insurance risks that follow fall into one or more of the main categories: operational, strategy, compliance and reputational.
1. Data breaches
Businesses across all industries have seen a huge increase in cybersecurity problems in recent years. Chris Roach, co-founder and COO of Blackswan Cybersecurity, said data hacks have hit fast-food retailers and e-commerce businesses particularly hard. However, he focused his attention on businesses that accept credit cards.
One of the most important things you can do to prevent fraud is ensure your credit card technology meets EMV standards. Every company should also review its compliance with Payment Card Industry Data Security Standards (PCI DSS).
“Complying with PCI DSS protects a merchant against digital data security breaches across their entire payment network, not just a single card,” Roach said. “Failure to comply can result in penalties and fines if a data breach does occur on your end.”
Cyber insurance is also an important consideration for small businesses. Myles Gibbons, president of the commercial accounts group at Travelers, pointed out the frequency of data breaches occurring in companies of 250 or fewer employees.
“Cyber coverage has grown increasingly important to all types of businesses, and can help to protect them from the costs of data breach notification, remediation, card payment penalties, crisis management and public relations,” he added.
2. Property damage
Hurricanes, snowstorms, floods and fires can throw a serious wrench in your company’s ability to operate normally. While your storefront or office may not have been entirely destroyed, chances are you won’t be able to run your business from that location while repairs are occurring.
“Only 50% of small business owners have a written business continuity plan, according to the Travelers Business Risk Index,” said Scott Humphrey, second vice president of risk control at Travelers. “Between severe weather events and the increasing reliance on a complex network of technology and supply chains, the risks of business interruption are plenty.”
Your first line of defense against property theft or damage is insurance coverage. Gibbons noted that some companies aren’t adequately insured to their true values.
“Ask yourself if you have enough coverage to rebuild a business after a total loss,” he said. “Business owners should make sure their building and its contents – including shelving, displays, inventory and any new equipment – are properly insured. Properties should be insured to their full replacement value – not market value – including any recent improvements.”
Michael Freed, a business litigation attorney at the Gunster law firm, urged business owners to consider business interruption insurance to keep their cash flow going, even if operations have been halted temporarily.
“Business interruption insurance provides coverage for lost revenues and profits arising from uncontrollable interruptions in business operations, such as those arising from natural disasters or a building fire,” Freed said. “When that type of casualty strikes, business owners need not only to rebuild where there has been physical damage but to offset for missing revenues while they do so. This is particularly critical for businesses with limited capital reserves.”
Beyond that, Humphrey advised developing a plan so your business has a protocol to follow should such an interruption occur.
Did You Know?
Most businesses will experience an interruption in service if they have a property damage claim, but commercial property insurance doesn’t cover lost revenue – just the lost property. Business interruption insurance is needed to cover the lost revenue.
“To develop a plan, businesses should identify threats or risks most likely to occur based on historical, geographical, organizational and other factors, [and] conduct a business impact analysis [to] identify [what is] critical to the survival of your business,” he said. Then, “adopt controls for mitigation and prevention, which can include emergency response, public relations, resource management and employee communications.”
3. Human capital costs
If you have employees, you have a significant amount of risk. Whether an employee is performing a labor-intensive task, driving a company vehicle or interacting with the public, there is a risk to the company, said Bryan Robertson, partner at Hatcher Insurance.
“The need for industry-specific training and internal loss controls is apparent now more than ever,” he said. “The employee needs to understand how their decisions and actions can tremendously affect the company’s well-being, both positively and negatively.”
According to Tony Consoli – national practice leader for health care, life sciences and alternative risk at CBIZ Insurance Services – changing market dynamics can mean major cutbacks across the board, which can also be an unexpected financial risk.
“Although making changes to the workforce is inevitable … during tough times, very few business owners know the risks involved with layoffs,” Consoli said. “Unemployment insurance costs can be an expensive burden on employers.” [Related article: The Small Business Guide to Unemployment Insurance]
Workers’ compensation insurance is mandatory for businesses with employees, but there are other insurance coverages you can obtain to mitigate your risk. Robertson advised looking into management liability and employment practices liability insurance.
“This coverage protects the owners and managers from suits related to discrimination to potential, current and past employees, as well as third-party claims,” he added. [Related article: Small Businesses Without Insurance Take Dangerous Risks]
Thoroughly planning for employee departures is the best thing you can do to avoid financial and legal recourse. Consoli recommended offering benefits – such as severance packages, payment for unused time off and continuing health insurance coverage – to laid-off employees. He also advised focusing on pending workers’ compensation claims that might be affected by layoffs and on conducting midyear reviews of your resources to scale back when necessary.
4. Professional service mistakes
Service providers like accountants, consultants and web developers all face the continual risk of customers seeking legal recourse if their “product” doesn’t meet expectations. Kevin Kerridge, CEO of small business insurer Hiscox USA, said that a common challenge for many small business owners is overcoming the mindset that their work is so good that no client would need to sue them.
“A business doesn’t have to make a mistake to face an allegation,” he said. “One lawsuit, even if unwarranted, can cripple a small business in terms of time and money.”
Kerridge recommended that owners of any service-based business consider professional liability insurance.
“This coverage protects a business in the event that they receive a lawsuit alleging that they have made a mistake [and covers] defense costs and resultant damages up to an agreed limit, typically $1 million,” he added. “We see a range of claims on this, from tax preparers making a mistake on a client’s tax return to technology service providers delivering a substandard work product.”
When exploring insurance options, check with any professional services organizations to which you belong. They may have member benefits with inexpensive professional liability insurance – a great way to save on insurance costs.
5. International manufacturing and export/transit issues
Many companies utilize overseas factories to manufacture their product or export products internationally. But a lot can go wrong during this journey, explained Lou Camhe, vice president of sales at BNC Insurance and Risk.
Camhe recommended contingent business interruption insurance to soften the financial impact of a problem with a vendor in your supply chain, such as a fire at your manufacturer’s factory. He also suggested foreign package policies to extend your insurance coverage to international exposures you may have.
6. Building projects
According to the U.S. Census Bureau, U.S. construction costs were up 17.5% from 2020 to 2021 – the highest spike since 1970. According to Consoli, construction comes with a fair amount of risk that business owners should consider before moving forward with a contract.
Consoli advised carefully reading your insurance policies to understand what it does and doesn’t cover in terms of damages or injuries that occur during the project.
“Carefully review the insurance coverage and costs related to the project,” he said. “What if a worker is injured on the job? Who pays for water damage during a storm? What happens if materials for a build are weeks late and this prolongs the entire project? Make sure all of your ducks are in a row before the expansion. Doing so will guarantee proper coverage while also mitigating financial risk to potential insurance overbillings.”
How to determine your company’s biggest insurance risks
Every industry and every individual business within an industry contends with different levels of risk, both in terms of the probability of something happening and the severity of the consequences, Kerridge said. However, ignoring those risks is simply not an option.
“There is no substitute for running a business professionally and not cutting corners, but however careful you are, bad things happen,” Kerridge said. “It’s worth buying as much insurance as your budget allows, as a backstop.”
“Partner with an appropriate carrier that is invested in your company’s long-term success and provides the necessary loss-mitigation tools,” Robertson added. Each carrier has its own industry specialization, and it is important [to work] with a broker who will provide a complete risk management program, rather than merely a cost-based approach.”
To assess your level of risk, Freed advised selecting and building relationships with a “dream team” of advisors: an attorney, accountant, insurance broker and banker. Each has something valuable to contribute to minimizing risks efficiently and effectively, he said. [Related article: Finding the Right Accountant for Your Small Business]
“An advisory dream team, empowered to be proactive on your behalf, can help anticipate and avoid pitfalls that befall many business owners,” Freed said. “The old adage is entirely true when it comes to risk mitigation: ‘An ounce of prevention is worth a pound of cure.'”
How to choose the right insurance for your business
Not every business needs every type of insurance. Here’s how to choose the right insurance for your company:
- Assess your exposure to a particular risk. If you don’t have products or supplies being transported, or they are insured by the company shipping them, you likely don’t need an inland marine policy. However, you might still need contingent business interruption insurance because a mishap would stop your ability to manufacture and sell products.
- Analyze your legal responsibilities. Do this with an insurance agent or an attorney to see what the most common claims might be against your organization.
- Decide how much coverage you want. Getting more coverage is more expensive, so you’ll want to balance getting the most protection for a price that fits your budget.
- Pick a provider based on your industry. Different providers specialize in different fields. Find a provider that understands your risk and will help you mitigate potential claims.
Tip
This list of more than 20 types of small business insurance is a valuable overview of the policies you should consider for your company.
Why is insurance risk mitigation important?
Every business owner deals with risk in their company every day. Mitigating risk is crucial for reducing the number of claims and lawsuits your firm might face. Having the right insurance policies in place will provide protection should a claim emerge. Insurance is an inexpensive way to cover the legal costs associated with claims and handle the actual settlements that arise from them. If you don’t have the right policies beforehand, your organization could suffer the consequences.
Kimberlee Leonard and Matt D’Angelo contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.
