If you are operating a small business, you will probably need some kind of insurance. For example, many states require businesses to have workers' compensation insurance in case their workers get injured on the job. Other kinds of risks can be insured as well. You should take specific steps in deciding whether you need insurance and then choose your insurance from available options.

What Is Insurance?

Insurance is the shifting of the risk of loss from one business or individual to another. The insured purchases an insurance policy from an insurer to cover a specific risk, such as fire damage to business property, and if the insured risk occurs, such as a business office being damaged by fire, the insurer pays the insured for the damage.

Deciding to Insure or Not to Insure

You should take the following steps in deciding whether or not to buy insurance for your business:

  • Identify the various ways in which the business might suffer a loss of property or assets
  • Decide whether the risks should be insured
  • Contact an agent, broker or insurance consultant to get advice as to the amount, type and cost of coverage that your business might need
  • Perform a financial analysis of the business to determine what forms of insurance you can afford and the probability that losses will occur
  • Inspect business facilities and operations and compile a list of past losses and their severity
  • Gather data about the demographics of your workforce
  • Choose the form of insurance that you need

Choosing Insurance

After you identify your business's potential exposures to loss, you can choose from many forms of insurance to cover potential losses or you can choose to fund potential liability by yourself, which is called self-insurance.

Usually, a business will seek a "direct writer" insurance company to underwrite its risks. If that is not available, you may seek coverage from a surplus line (non-admitted) insurance company. A surplus line insurance company can underwrite many different types of risks and have its own loss fund but, if the insurance company were to become insolvent, its policyholders would not be eligible for state guaranty fund protection.

Another common arrangement is the use of excess insurance in addition to the primary insurance offered by a direct writer. If you purchase excess insurance you are buying insurance in an amount greater than the highest limits of liability that a primary insurer is willing to offer for a particular risk.

A business seeking insurance may obtain coverage from international or national insurance exchanges or foreign insurance companies. Insurance exchanges and foreign insurance companies ordinarily insure high risks or unusual risks.

Insurance Providers

You can obtain business insurance from the following kinds of providers:

  • Mutual insurance companies are organizations which are owned and controlled by and operated for the benefit of the policyholders. They are not operated for profit. Excess monies which have accumulated from the collection of premiums after the payment of losses and expenses are returned to the policyholders in the form of a dividend.
  • Stock insurance companies are profit-making corporations. The stockholders of the insurance company provide the necessary capital to establish and operate the insurer, elect the board of directors, and, in return, receive their share of any profits in the form of stock dividends.
  • Insurance exchanges, such as Lloyd's of London, are made up of syndicates which agree to accept risks for the own syndicate accounts.

Businesses can self-insure by financing expected losses or agreeing to absorb certain losses. Financing losses involves setting aside funds in an "insurance reserve," in a manner similar to paying premiums. Enough money is set aside to cover predicted losses.

Large corporations often form separate insurance companies to handle the risks of the parent company. These separate companies are termed "captives." The primary difference between businesses that form captive insurance companies and those that self-insure their risks is that the premiums paid to captive insurance companies may be tax-deductible but contributions made by a self-insured business to fund its potential losses are not. Other advantages to forming a captive insurance company are:

  • Potentially lower insurance costs than those of a commercial insurance company and
  • The ability to obtain coverage of risks that commercial insurers will not provide

If you have any questions about obtaining insurance for your business, contact a small business lawyer in your area.

Questions for Your Attorney

  • How do I decide whether or not to buy insurance policies for my business?
  • What do I do if I cannot find a "direct writer" insurance company?
  • Is self-insuring my business a good idea for my situation?