SMALL BUSINESS INSURANCE & RISK MANAGEMENT GUIDE
Limiting Exposure to Loss
Avoiding Risks
One principle of loss prevention and control is the same in business as it is in personal life: avoid activities that are too hazardous. For example, a merchant may decide not to sell a particular product because it is likely to injure customers; thus, the firm avoids a product-liability exposure.
Or if you can't avoid an exposure completely, minimize it.
An apartment owner may decide against constructing a new building on a rural hillside site that has a long history of brushfires. Instead, he builds on level, suburban land, which is supplied by town water and is two minutes from a fire station. Although exposure of loss from fire can seldom be eliminated completely, this owner has reduced the possible severity of loss by choosing a safer site.
Look again to see if the extent of possible loss can be further reduced.
That same apartment owner, for example, may decide to build using fire-resistant construction and materials, thereby reducing the chance of a fire's spreading. He may also decide to install smoke detectors, fire alarms and automatic sprinkler systems throughout the building.
Risk Retention
A business owner may decide that the firm can afford to absorb some losses, either because the frequency and probability of those losses are low or because the dollar value of the losses is manageable.
For example, a firm owns several business vehicles. The drivers have an excellent safety record, and exposure to collision is low because these vans cover uncongested rural routes. These are older vehicles, and their book value has decreased substantially. The firm decides to drop the collision coverage completely. If an accident damages one or more of the vans, the firm will pay for damages with company funds. In effect, the firm has decided to retain the risk itself rather than transfer the risk to an insurance company by paying for collision insurance. An alternate is that the firm could decide to retain only part of the risk and insure the rest.
Transferring Risk
Another method of managing exposure to loss is by transferring the risk. Although most businesses do this by buying insurance (which transfers some or all of the risk to the insurance company), there are noninsurance options.
- In the above example, the firm may decide to eliminate the collision exposure completely by selling the firm's vans and hiring a local delivery service. This solution eliminates not only the collision exposure, but also the exposures associated with owning and maintaining the vans. In effect, the firm has transferred all of the expenses to the local delivery service.
- To reduce exposure to property damage, a retailer may decide to cut in-store inventories and to handle certain items on a special-order basis only. The owner will place small reorders with suppliers more frequently. The result? Lower inventory values in the store, therefore, lower exposure. The retailer is actually transferring much of the exposure of property loss to the suppliers.
Insurance as a Risk Strategy
The most common method of transferring risk is insurance. By insuring your home and car, you have transferred much of the risk of loss to the company that issued the policy. You pay a relatively small amount in premium rather than run the risk of not protecting yourself against the possibility of a much larger financial loss.
In business insurance, as in personal insurance, only you can decide which exposures you absolutely must insure against. Some decisions, however, are already made for you:
- Those required by law (such as workers' compensation).
- Those that others require. For example, you cannot register or operate a business vehicle in most locations unless you can prove that it is insured. Similarly, few lenders will finance property acquisition or construction unless it is adequately insured and the lender is named on the policy as having an insurable interest.
This article is reprinted by permission of the SBA and The Travelers, Hartford, Connecticut.
For more information on SBA programs go to www.sba.gov