Underinsuring your business can be devastating in the event of a loss, yet overinsuring your business can waste money with each payment of a premium. Risk management is the discipline that allows us to plan for an appropriate amount of coverage in each aspect of our business lives. This article outlines 6 steps to help you manage your risks and choose the appropriate amount of coverage for your business.
Step 1 – Analysis of Risk
Every aspect of our business lives subjects us to risk. Our products and services create risk to the customer. Our facilities create risk to persons entering them. Our contracts create risk of non-compliance. Our hiring and employment practices create risk of employee lawsuits. Our marketing practices create risk of misrepresentation. Every decision we make as managers subjects us to some degree of risk.
A certain degree of risk is necessary to make a profit. Sustaining a profit requires identification and management of those risks. The first step is completion of a risk management audit. The audit should consider each point of contact between the business and its employees and customers.
Liability risks relative to customers should be evaluated from the customer’s point of view. The customer’s steps in dealing with the business must be thoroughly understood and the risks completely documented. That means walking the premises as well as reviewing all paperwork and examining all products and services being offered for sale.
Liability risks relative to employees should be similarly detailed. Primary concerns are risk of injury, equity and legality of employee policies and fairness of hiring and promotion practices.
Step 2 – Assumption of Appropriate Risk
If a business is to succeed, it must assume some level of risk. The key is to understand the risks and assume only the risks that are prudent. Circumstances that could make risk assumption appropriate are 1) very remote possibility of a loss event; 2) minimal damages would arise from a loss event; or 3) the business can afford neither the loss nor the insurance to cover a potential loss. As the entrepreneur becomes more successful—and has more to lose—the number of events listed in category 3) will become fewer and fewer.
Step 3 – Addressing the Cause of Risk
Some risks are obvious. No prudent business owner would operate under conditions that are known to be unsafe. However, many otherwise prudent business owners overlook opportunities to run a safer and more productive facility. It helps to bring in a safety engineer from time to time, but in the meantime, listen to your employees who are working the operations every day. If employees complain about the reliability or performance of their tools, take those complaints seriously. By providing the right tools, you not only reduce risk of accident, you also improve productivity. There can be payback in both improved margins and reduced insurance costs.
Step 4 – Transferring Certain Risks to Third Parties
One effective way to reduce risk in a small business is to transfer the risk to someone else—especially if that someone else is larger and has more wherewithal to manage the risk. Rather than training your personnel to perform tasks that are not integral to your business, consider outsourcing those tasks. Make sure, however, that you have a clear and written understanding about the risks that are being transferred. Plus you should be aware that even though you transfer the primary responsibility for a risk, you may remain liable should the subcontractor be unable or unwilling to cover a claim.
Step 5 – Self-Insurance
There are circumstances when it makes sense to set aside reserves to cover certain types of loss rather than to pay those same funds to an insurance carrier. This technique can be dangerous when large claims are involved and the reserve fund has not been adequately funded or the business operation is so small that there is no base over which to spread the risk. The right circumstances typically involve small, recurring claims, and/or multi-unit operations. With small, recurring claims the cost is predictable and there may be no need to pay an insurance carrier to administer the claims. With multi-unit operations, there is a broad enough base of operations to consider spreading the risks.
Step 6 – Purchase Business Insurance
The first 5 steps have discussed techniques to reduce the need for insurance or the cost of insurance. Each business, however, will find that many risks can only be mitigated through the purchase of insurance coverage. Consider the risks of liability, property damage and loss of production from your workers. Some level of insurance will be necessary in each of these areas. If you start with a basic package policy, make sure you examine special risks that are indigenous to your business and investigate additional special coverages that may be available to cover those risks.
Most importantly, press your insurance agent to earn his/her commission by providing a high level of advice and consultation about management of your risk. If one agent doesn’t want to earn your commission dollars, look for an agent who will.