So what insurances do I really need?
If you're in business, there is a never ending list of insurances you can purchase, against a myriad of risks.
One part of my role as CFO is to ensure my clients have enough insurance to protect against those factors over which we have no control, without overspending. Every dollar we spend on insurance is one we can't spend on product development or developing the right sales & marketing channels to grow the business.
Early in my career, I was fortunate enough to run the insurance program for a large engineering firm and as part of that I did get a good understanding of how the insurance industry works and how they make money. This has been extraordinarily useful since to assess whether an insurance product is good value or not.
Before I start, I should emphasise I have a reasonably high risk tolerance and a view that if things go wrong, they can be fixed, there is always a solution. My philosophy on insurance is to cover those events which, if they did happen, would break the business.
If insurance is one of those things that helps you sleep at night, that in itself does have value. Just be aware that's what you're paying for.
To begin with, let's look at why an insurance policy costs what it does. There are 3 factors:
- The $$ value of risk being covered
- The likelihood of that risk happening
- The amount you'll contribute in the event of a claim
By way of example, one type of insurance is called "public liability" (I talk more about the various types of policies below). This is similar to the "green slip" insurance you pay on your car - it's to cover personal damage suffered by another person as a result of your business activity.
You normally can get public liability coverage up to $20m for a premium of $300 - $500 per year. However, green slip insurance (also known as Compulsory Third Party, or CTP insurance) is much more expensive). Why is that?
There's two factors. The first is that there is a much higher rate of personal injury caused by motor vehicle accidents than business activities, hence there's a lot more claims.
The second is what's known as the "deductible". In the event of a claim, this is the amount you pay, the insurer will pay the rest. The higher the deductible amount, the lower the premium. Most public liability policies will have a deductible amount. CTP insurance does not.
One of the first things I do in looking at a business's insurance is see if I can reduce the premiums by increasing the deductible amount. That's not always possible however I do ask the question.
Have you ever bought either travel insurance or rental car insurance and for "an extra $10 / day, you can remove the deductible"? There's a reason for that. How many times have you made a claim on one of these policies, vs taking them out? On average, the extra $10 / day spread over hundreds' of policies generates far more in revenue for the insurance companies than the extra they pay in event of a claim.
Hence I always say no to reducing deductibles, to extended warranties (which is also an insurance policy) and to all the add-ons.
So, as a business owner, which insurances are a good idea to have?
The basics are as follows:
- the public liability I referred to above
- if you have staff (or employ yourself), workers compensation is mandatory
- contents insurance
- building insurance for a rental property - this will depend on the conditions in your lease agreement.
Others then depend on your business model:
- if you sell physical products, then a product liability policy covers for damage to a customer's property due to product defect.
- if you provide professional advice (legal, financial, medical) then a professional indemnity policy covers for business loss to your clients due to incorrect advice. For self employed people the policy amount is normally approx $2m and the cost of the policy starts from $1,000 + / year, depending on the profession you're in.
- if you have taken investment from investors, they may want to be a Board director. Being a director means taking on personal liability for business related decisions. There's a policy called "directors & officers" insurance. The minimum for one of these is $1,500, I have seen policies up to $20K in annual premiums for more complex situations.
Many of these policies now come under an umbrella called "management liability" that can also cover, for example, defending against claims brought by prior employees for unfair dismissal.
- IT liability: this is a new one for technology companies that removes a lot of the "grey" as to whether you're selling a product or a service. It's intent is very similar to both product and professional indemnity insurances however it is structured to work with the technology sector far more effectively
- Cyber insurance is a growing necessity for anyone who trades online, as it protects against hacking, identity theft, fraud etc that happen online.
- Key person insurance. Is there someone in your business who is critical to its operation? How would you replace them if something happens to them. When I've put these in place before, often that scenario would involve hiring 2 or 3 people with different skillsets hence the policy needs to cover for that. In tech companies this is normally the "genius" who wrote the code, for example.
- Travel insurance if you or your staff travel for business, especially internationally. In particular, if you go to the US the travel insurance on your credit card won't cut it (especially for medical).
So what's right for you? A good insurance broker is a person worth getting to know.
How do you find a good one? Remember they are economically motivated for you to have as many insurance policies as possible as they earn a commission on the premium you pay. If they recommend you don't need a certain insurance, then that's a good sign they're looking out for what's best for you and want to build a relationship with you.
I heard a story this week about an insurance to pay for the cost of audits should the Aust Tax Office come knocking.
This policy was being promoted by an accountant to their client. My "inner cynic" radar was pressed for the following reasons:
- it is likely the accountant earns a commission on this policy
- the ATO does audits for two reasons. The first (and more likely) is because you've crossed the line on one of their internal indicators, such as the level of deductions vs your income for the industry you're in.
- a good accountant adds value by making sure you stay within those ranges
- the second reason the ATO does an audit is due to random selection. The likelihood of this happening is very small, vs the cost of this insurance over several years. Let's say it happens once in 10 years, and you've paid $200 / year for the insurance. That's $2,000 in premiums. A good accountant will also make sure your records are in good order so the cost of supporting such an audit drops well below this level.
Hence this policy, in many respects, implies the accountant is less effective in the two areas they are supposed to add the most value to you, their client. So who's the insurance for in this case???
As I said at the beginning, if such a policy helps you sleep at night, go for it. That does have value in the crazy world of being an entrepreneur. Just make sure you understand what you're paying for.