Nearly all insurance policies contain limitations on the maximum amount of a judgment payable under the contract, and setting these limits is one of the most challenging aspects of insuring your company.
“Honestly, this is one of the hardest questions for people to answer and understand,” says Scott Nuelle, vice president, ECBM Insurance Brokers and Consultants. “For most people, it comes down to what they can afford. In many cases, companies are not buying enough, but they flat-out say they can’t afford to buy any more. So that becomes the key issue.”
Smart Business spoke with Nuelle about why insurance limits matter and how to choose the appropriate amount for your business.
Why is it important to purchase sufficient insurance limits?
In addition to the more obvious need to adequately protect your business and possibly personal assets, an often-overlooked component is the ability to appeal a large verdict against you. If the jury slaps you with a $10 million verdict and you’ve only got limits up to $5 million, the insurance company will post bond for the appeal of $5 million, but you have to post the other $5 million yourself in order to appeal. Otherwise, you lose.
If you don’t have adequate limits to appeal any verdict, you need to have the financial wherewithal to appeal. The lack of ability to appeal a verdict could put you out of business. You may be able to win that case on appeal, but if you don’t have the money to post bond, you’re finished.
What are the keys to choosing the right insurance limits?
First, you want to look at your assets and set limits that are appropriate to protect those.
The next thing you want to look at is your business operations and the likelihood of a large lawsuit. Are you in an industry where multiple people or properties could be damaged? For instance, someone in the hotel industry could have an incident in which many people are injured, a situation in which higher limits would be useful.
Contractors and trucking companies also operate in an environment where many people could be injured. If you are in those types of industries, you should consider the likelihood of large lawsuits, and for liability purposes, you are going to want to consider higher limits.
What can companies do to research appropriate limits for their specific needs?
Have your broker search for settlements and verdicts in your industry. That gives you an idea of common verdict results in those areas.
Verdict results can change by jurisdiction, as well. Some jurisdictions have historically delivered larger verdicts. If you have operations in one of these regions, you’re going to want to carry higher limits than you would if you were exclusively operating in an area that typically does not return higher jury verdicts.
When your broker completes the search, you’re able to see what verdicts are being returned against companies in your industry.
Your broker should also be able to benchmark your company by industry and size while planning and completing the research. Brokers can look at other companies and determine whether the limits you’re carrying are adequate based on what your competition is doing, based on the likelihood of large loss, as well as verdicts and settlements.
You should develop a matrix of where you fall within the realm of these different factors that can determine what limits you should be carrying.
How should companies determine limits for other types of coverage?
For directors’ and officers’ coverage, typically a company would look at its market cap and what its potential loss could be in the event of a lawsuit. As a basic guideline, companies should carry limits of at least 10 percent of their market cap. On employment practices liability insurance, the key issue to look for is how susceptible your company is to a class action lawsuit. If you are in the retail or hospitality industry, you are generally very susceptible to that type of lawsuit and would likely want to carry higher limits than if you were not in one of those industries.
If your company is in the manufacturing or retail sectors, you may have product recall coverage. The keys to determining limits for that coverage start with the likelihood of the chance of a recall. What are the potential costs associated with that, not only in terms of the product but in terms of implementing the recall?
Make sure you include that coverage in your insurance and set appropriate limits based on your analysis of those factors.
Are there ways businesses can keep costs down and still buy the appropriate limits?
The most common method is through the use of deductibles. Deductibles can help you reduce premium as opposed to not carrying enough limits to insure situations that could potentially put you out of business.
You want to set a deductible that will allow you to control costs but won’t interrupt your normal business operations in the event of a loss. It should be a level that you can fund through ordinary income.
Have your broker present multiple options for you to consider regarding the cost for various deductibles and limits. Determine if paying a loss up to the deductible will affect your business operation.
At that point, it becomes a financial measurement more than an insurance measurement.
Scott Nuelle is a vice president with ECBM Insurance Brokers and Consultants. Reach him at (610) 668-7100 or [email protected].
