The Inns and Outs of Business Insurance and Risk Management

Presented by Legal Aid of Arizona, 480-389-6718; legalaidaz@gmail.com

Business is inherently risky, and business owners and entrepreneurs thrive on risk. Nothing is certain when starting a business, trying to keep it going, or deciding to expand it into new markets. Most business owners have studied market statistics, analyzed the competition, crafted a business plan, and gathered at least some of the capital they need to make a go of it. Too often, however, business owners do not think enough about the legal risks involved in running a business—even a thriving business. This article discusses risk management and how to plan for, and deal with, some of the liability and exposure you face as a business owner.

Risk Management

There is no way to eliminate risk. The only thing you can do is try to account for it. Managing risk requires balancing between the costs of insuring against a negative event and the cost of the negative event occurring without insurance. In an ideal world, your insurance coverage would mirror your exposure. In reality, it is nearly impossible to calculate your risk or pay for all of the insurance you might want. In addition, your business is always changing. Customers come and go, new opportunities present themselves, and certain projects fall by the wayside as the market fluctuates.

The most important part of a risk management plan begins with the business owner making sure the organization is running properly and efficiently. When you think about risk, you have to think about how your organization actually operates, not just how it is supposed to operate or how you might want it to operate. Who are your employees? Who are your customers? Do you have adequate policies in place to protect and guide your employees? Do you regularly review and audit your policies or do you draft them up and file them away?

The Law of Negligence

In the context of business liability, your exposure will usually involve claims of negligence. The law of negligence is complicated and full of nuance. Put simply, negligence simply means the failure to act as a reasonable person should under the unique circumstances of the case, which leads to injury or damages. This is a vague standard and leaves a lot of room for litigation.

The key legal elements to support a negligence claim are duty, breach, causation, and damages. First there must be a legal duty to act (or refrain from acting) in a certain manner. Then you have to show the person did not act according to that legal standard. Even if you can prove a breach of duty, you still have to prove that the action (or failure to take action) helped produce an injury. This is known as “causation.” Causation is more complicated than it sounds. For example, if you negligently crashed your car into someone who had a heart condition, your negligent act did not cause or give rise to that person’s heart condition. It may have made things worse, but you can’t be held responsible for the condition in the first place. Similarly, if the damage or injury was inevitable no matter what you did, your negligence may not be considered the true cause.

Another difficult issue is damage and injuries and how to put a monetary value on them. The law entitles victims of negligence to be made whole or paid so that they are in the same position that they were before the accident. There are several types of damages and injuries. For example, most car accidents cause physical damage to the vehicles involved. If your vehicle is stuck in a repair shop for weeks, you suffer from a type of damage called “loss of use,” which is the hassle and expense of obtaining a rental or otherwise being without your vehicle. If the vehicle gets repaired the owner will likely take a hit if he decides to sell it; this type of damage is known as “diminished value.” Many accidents involve damages in the form of medical injuries to drivers, passengers, or pedestrians. This type of damage is known as “bodily injury.” Bodily injury is often the most complicated issue in an accident case.

Bodily injury involves not just medical issues about the nature and severity of an injury, but also pain and suffering. How can you put a monetary value on pain and suffering? How much money will compensate you for a broken leg, a scar, low back pain, a broken finger, or a bruise? There is no precise answer, which is why figuring out the true value of your claim requires experience and training.

Employer Liability (“Vicarious Liability” or “Respondeat Superior”)

An important legal concept to keep in mind is Employer Liability for the acts of an employee. This is sometimes referred to as “vicarious liability” or the latin phrase, “respondeat superior” (literally translated: “let the master answer”). If an employee causes damage in the course and scope of his job, the employer may be held liable along with the employee. For example, consider the case of a pizza delivery driver who crashes into another vehicle and causes serious injury or death. The victim (or surviving relatives in the case of a death), will not only sue your driver, they will also sue your company. This is why it is important to consider the activities of your employees when thinking about risk management.

Comparative Fault

Arizona law recognizes the concept of “comparative fault” which means that both parties may be partially at fault for an accident. This is easiest to understand using the example of a car accident. If a driver was trying to make a left turn but you were speeding when you hit his car, the other driver might be deemed 80% at fault and you might be deemed 20% at fault. Thus, you will be responsible for up to 20% of the other driver’s damages. The other driver will be responsible for up to 80% of your damages.

Intentional and Criminal Actions

Few, if any insurance policies, will cover you from any intentional damages you may cause. Similarly, insurance cannot cover you for intentional criminal activities like fraud or extortion. This is important to keep in mind as you manage your employees and evaluate your risk management plan. Don’t be lulled into complacency by a high-limit insurance policy.

Premises Liability: Slip and Falls

In Arizona, the duty owed by landowners to someone who enters their property is determined by the status of the entrant as a licensee, invitee, or trespasser. Wickham v. Hopkins, 226 Ariz. 468, 471, ¶ 9, 250 P.3d 245, 248 (App. 2011). A licensee is “a person who is privileged to enter or remain on land only by virtue of the possessor’s consent,” such as a social guest. Restatement (Second) of Torts § 330 (1965) (cited in Nicoletti v. Westcor, Inc., 131 Ariz. 140, 142–43, 639 P.2d 330, 332-33 (1982)). A landowner has no duty to a licensee “other than to refrain from knowingly letting him run upon a hidden peril or wantonly or wil[l]fully causing him harm.” Wickham, 226 Ariz. at 471, ¶ 9, 250 P.3d at 248 (citations omitted). With respect to invitee, landowners have a duty to “maintain their property in a reasonably safe manner.” Nicoletti ,131 Ariz. at 142-43, 639 P.2d at 332-33.

Put simply, any customers who enter your property will likely be deemed “invitees.” Thus, you have a legal duty to keep your business property maintained “in a reasonable safe manner.” This often comes up in slip and fall cases, where a customer slips and injures himself. The focus of the case is likely to be how the accident happened. Was it the result of a failure to reasonably keep the floor clean and dry or was it a freak accident? Did you or your employees have knowledge of a potentially dangerous situation and do nothing (e.g., a huge crack that is obviously a tripping hazard)? Liability for a slip and fall is often difficult to prove. However, under the right circumstances, your exposure could be huge. Falls can cause serious injury like broken hips and legs that require tens of thousands of dollars in medical treatment.

Insurance: Business Owners Policy (“BOP”)

There is no doubt that insurance is a key piece of any risk management plan. Very few businesses have enough capital set aside to cover for significant liability. Insurance is a way to “outsource” your monetary risk to a company that has enough capital and customers to protect against any liability that may arise among a few of them.

Most business face similar basic exposures, which is why many insurance companies package the most needed coverages into what is commonly called a Business Owners Policy (“BOP”). Often, these policies are standardized and have common policy language and exclusions. The following are the most common coverages in a BOP.

Commercial General Liability (“CGL”)

The cornerstone of insurance for businesses is a Commercial General Liability policy or CGL. In general, this policy gives you general coverage for accidental “occurrences” that cause “bodily injury” or “property damage,” which are technical terms defined in the policy. Put simply, a CGL policy will cover accidents like customer slips and falls, defective products, and damages you or your employees cause to another’s property. The policy will pay medical bills of customers injured on your business property. The CGL policy will typically exclude and not cover intentional actions by your employees, injuries to your employees (for that you need a Workers’ Compensation policy), or allegations that you breached a contract or failed to pay. As with any insurance coverage, the insurance company has a “duty to defend,” which means that if you are sued for something covered under your policy the insurance company will hire and pay an attorney to defend you.

There are fifteen common exclusions in most CGL policies, including the following:
• Claims arising from contracts are generally excluded, yet this is an area of significant liability for most businesses. Contract claims are discussed below. Some insurance companies will allow you to purchase limited coverage for contract claims.
• Electronic property and data is usually not covered. You need to purchase this type of coverage.
• Claims for harassment, discrimination, and wrongful termination are not covered. For coverage of these claims you need an Employment Practices policy (see below).
• Damages to your own business property are not covered under typical CGL policies. Only damages to other people’s property are covered. If you are concerned about damage to your own property, consider purchasing property insurance, which is discussed below.
• As noted, intentional actions like assault and battery are not covered under insurance policies.

Property Insurance

A CGL covers accidental damage to another’s property, but will not cover damage to your own property. For that coverage you need property insurance, which will cover your own business property for things like theft, vandalism, and fire. Typically, property insurance will include coverage for office furniture, inventory, and computers. Your policy may cover equipment breakdown and water damage. Most policies exclude and will not cover damage from electronic failure or hacking.

If you work out a home office, keep in mind that your personal homeowner’s or renters’ insurance policy will exclude coverage arising from business activities. If you have customers who come to your home for business, you should consider purchasing business insurance or you may find out when it is too late that you are not covered.

Commercial Auto Insurance (“Business Auto”)

If vehicles are used for your business, you need to purchase a commercial auto policy. Personal auto insurance exclude damages incurred when a vehicle is used for commercial purposes. The classic example is a pizza delivery driver who causes an accident while delivering a pizza. Even if the driver has personal auto insurance, that policy will not cover his liability. If your business requires employees to use their cars for deliveries, you need to make sure you are properly covered. Driving is probably the riskiest thing you do every day. In Arizona there were over 100,000 car crashes in 2013. On average, two people were killed on Arizona roads every day as a result of vehicle accidents, and car accidents in Arizona cause almost $3 billion in damage every year.

Workers Compensation Insurance (“Workers Comp”)

In Arizona, workers’ compensation coverage is mandatory for every employer with 1 or more employees. Sole proprietors are not required to carry workers compensation coverage. Employers who do not have workers’ compensation coverage face stiff financial and even criminal penalties. The good news is that a workers’ comp policy will cover employee injuries—even if the injury was your fault. The worker’s comp system is overseen by the Industrial Commission of Arizona (“ICA”) and is highly regulated. In general, injured workers have their medical bills covered as well as a portion of their wages depending on the nature and severity of the injury. Many cases revolve around whether work activity actually caused the employee’s injury as well as determining the true scope of the injury and circumstances of the accident. If a business does not have workers’ compensation coverage, the ICA has a Special Fund that will pay for the worker’s claim. However, the Special Fund will then seek to recover from employer all expenses associated with the claim plus penalties.

“Independent contractors” are not considered employees. However, the distinction between “employee” and “independent contractor” is often misunderstood and your employment contracts will not preclude an insurance company or state and federal tax collectors from determining that people you thought were “independent contractors” were actually employees. Unfortunately, many employers attempt to treat their employees as independent contractors, only to find out later that they were not. This can result in hundreds of thousands of dollars in tax liabilities and penalties.

To determine whether an independent contractor is really an employee, some key questions include: Does the company control or have the right to control what the worker does and how the worker does his or her job? Are the business aspects of the worker’s job controlled by the company? Is the work performed a key aspect of the business? For more information on this topic, go to http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee.

Directors and Officers (“D & O”) Liability Insurance

Directors and officers insurance protects directors and officers of a business from claims that they negligently mis-managed the business or organization without proper regard for the rights of others. The policy will pay any judgment for which the insured is legally liable, up to the policy limit. It also provides for legal defense costs, even where there has been no wrongdoing. When considering D & O policies, keep in mind that they:

• Typically cover cost of defending the directors and officers and will pay any resulting money damages when the corporation is not permitted to indemnify them or is financially unable to indemnify them.
• Typically cover management, staff, and volunteers. It may also cover claims for wrongful termination, sexual harassment, discrimination, unfair hiring/firing practices, mental anguish, and emotional distress.
• Cover misuse of funds, but probably not criminal fraud.
• Typically exclude deliberate or intentional conduct.
• Most D & O policies exclude coverage in situations when a director, officer, or business in fact profited or benefited from the actions.

Key Employee Insurance

Most business have a few people who are critical to its operations. A Key Employee policy can cover a business when certain key employees die or become disabled. This protects a business from some of the financial impact of losing a critical team member.

Errors and Omissions Insurance (“E & O”) or Professional Liability

An errors and omissions policy covers businesses that involve giving customers advice or making recommendations, like accountants and lawyers. Often this policy is referred to as professional liability or malpractice insurance, especially in the context of attorneys and doctors. An errors and omissions policy can also cover businesses that involve designing things for customers, like architects. For many professional businesses, an E & O policy is the most critical policy of all. Some professions make such coverage mandatory.

Employment Practices Liability Insurance

An employment practices policy covers liability arising out of the hiring and firing of employees, especially claims related to civil right and discrimination. Businesses that regularly hire, train, and fire employees should consider this type of policy. Businesses with few employees or infrequent turnover likely face less risk. However, those small businesses probably do not have human resource professionals and therefore may not be as on top of HR issues as bigger companies may be.

Umbrella Policy (“Excess Insurance”)

An umbrella liability policy provides general coverage over and above a company’s other liability policies and protects against catastrophic losses. An umbrella policy comes into play when the limits of another policy are spent, such as in the case of a serious accident or death or a high value lawsuit. The most likely scenario is an accident with a company car operated by an employee for business purposes.

Other Insurance Coverage

There are a variety of other special coverages that a company may want to consider. For example, a company that frequently hosts events may want to consider Special Event Insurance or a Host Liquor policy. Some of the risk from such events can often be handled through contracts with indemnity clauses. There is also Business Interruption Insurance, which covers your company for lost profits arising from equipment breakdown and other accidental occurrences. A technology company may want to consider Internet Business Insurance or a Cyber Insurance policy to protect from losses due to hacking and other internet activity.

Paying For Protection: Your Insurance Premium

Insurance is not cheap. How much insurance do you need? How much can you afford? Remember, risk cannot be eliminated. In general, beginning businesses face less risk at the beginning. After all, the most difficult hurdle for a business is simple survival. Just as you need not worry about vacations until you have food, shelter, and clothing, you may not want to worry too much about obtaining the highest possible limits and every possible coverage when your business is just getting off the ground. As your business grows, however, so should your risk management analysis. Plan to re-evaluate your needs repeatedly. Don’t wait until the end of the year or some ideal milestone. Instead, as you expand, think about adding the most relevant coverages and/or raising the limits of your policy. Remember to keep your insurance agent apprised of any changes to your business operations.
The underwriters at insurance companies evaluate a company’s risk for liability coverage based on numerous factors, such as the number of claims filed within an industry or probability of a claim for a similar type of company; the financial stability and longevity of a business; state laws; business products and/or operation; and a business’ approach to handling and preventing potential risks. Typically premiums will be affected by a company’s sales and payroll estimates prior to policy inception. If the actual amounts turn out to be higher after the policy has been issued, you may need to pay an incremental premium. If it turns out to be less, you may be entitled to a refund.
Other factors that influence your liability premiums include your type of business and the risks generally associated with it. For example, a toy manufacturer may pay $3 per $1,000 of sales. Thus, on $10 million of sales, the premium would be $30,000. A company that manufactures a less “risky” product or engages in a less risky business, such as a florist, may pay $1.50 per $1,000 of sales, or $15,000.

The Claims Process

Insurance is a complicated, competitive, and highly regulated industry. It is no wonder there are so many commercials on television. Lots of money is at stake: insurance is a billion dollar industry. So how do you get the coverage you have paid for? It all begins with the insured making a claim, informing the company about a potential loss. Insurance companies employ teams of people trained to investigate and evaluate claims, called “claims adjusters.” The job of a claims adjuster is to collect information, review records (including police reports, witness statements, and medical records), and determine the extent of the insurance company’s liability. But make no mistake, adjusters are employees of an insurance company. While insurers play an important and valuable role in society, the reality is that insurance companies do not make money by paying the maximum possible amount for your claim or by paying you as quickly as possible. Insurance companies maximize their profits by minimizing their risk and payouts whenever possible. And they have the resources and motivation to do so. Most claims adjusters have dealt with thousands of accident cases and attorneys. How many have you dealt with? Due to this power imbalance many people choose to hire attorneys to represent them when it comes to serious claims that involve lots of money or accidents involving an injury, a death, or significant property damage. A lawyer can help navigate the insurance process, which can be time-consuming and frustrating, and help resolve a claim fairly and efficiently.

Keep in mind that your insurance policy is governed not only by state law, but also by the terms and conditions of the policy itself, which is considered a contract between you and the insurance company. For this reason, insurance policies can be very different and can contain exclusions for certain situations. This is why it is important to carefully review your policy and any exclusions or amendments before making a claim. You are entitled to a copy of your insurance policy and your declaration page, which will summarize the types of insurance coverage that you have. Often, the precise way you present your claim can have an effect on how the insurance company treats it. Properly presenting your claim can mean the difference between a relatively quick claim evaluation and a long, potentially contentious review and assessment. The bottom line is that your insurance coverage is only as good as the amount your insurance company will actually pay in the event of a claim.
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Presented by Legal Aid of Arizona. This article is intended for informational purposes only and does not constitute legal advice or establish an attorney/client relationship.

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