How much insurance coverage is enough?

Andy Schwartze gives guidance for determining coverage for asset and revenue flow
Thursday, August 14, 2014

It’s the age-old question insurance buyers have been asking since the dawn of the industry. How much is enough? The answer can take one of two forms. The amount is either easily determined or impossible to know.

Where a quantitative number can be determined, it is never very difficult to arrive at the sum, especially in areas concerning asset and cash flow coverage exposures. In certain other less definable areas, the answer is simply to buy whatever the budget will allow.

The insuring of physical assets is uncomplicated. We determine what it would cost in terms of today’s labour and material input, to clean up the mess and replace the asset. The insured value needs to assume that a total loss can take place and must incorporate all of the costs that impact such a disaster. There are reliable technical tools available to make these determinations, and with the application of known government requirements, sound arithmetic will get the number right. Those who stolidly maintain that their asset can never be totally destroyed, fool themselves into saving a few dollars that will certainly not console them when disaster does strike.

In the area of “cash flow” insurance, the approach is different. Revenue that is produced by an operating business is the lifeline by which the business survives. The mere fact that the asset is insured, and can be fully replaced, does nothing to ensure ongoing revenues that are needed to handle numerous continuing obligations. Key people, for example, do not want to be forced to leave and go elsewhere. They were brought on board for a reason and are needed to manage the rebuilding process and, of course, to then carry on the business for which they were initially hired. We need to make sure that their salaries are protected until our repaired business is back up and running.

Certain other costs do not simply go away temporarily. Property taxes, loan interest, professional fees, advertising costs—there is quite a list depending on the type of business, and the type of costs that still need to be looked after even though the revenue stream may have temporarily dried up.

So, we insure that flow of funds. In the case of an apartment building, we call it rental income. In other sectors we give it different names. But the important point is that the insuring of the asset is only half the job…..insuring its revenue flow is the other half.

Employee dishonesty and liability insurance

Things become tricky in the arena of employee dishonestly and liability insurance. There really is no one expert who can identify the right amount of insurance coverage for this type of problem. In the case of employee dishonesty, which is a particularly emotional experience, often times the theft is triggered by personal panic resulting from an unexpected event in life. The perpetrator is generally unsophisticated and telegraphs his/her theft via some very obvious mistakes. On the other hand, the dedicated pro who is intent on deliberately ripping the company off, is a person to truly fear. From false supplier invoicing (an old but still effective trick) to the new world of cyber ransom, these thefts are generally conducted at a very high level of sophistication and are discovered long after the damage has been done.

When it comes to liability insurance—whether it is environmental, directors’ and officers’ liability, or just the “general commercial” coverage—the question of “how much” is really complicated. No plaintiff can be forced to limit the amount of money for which they wish to sue a person or business. We need only follow the news to see stories about lawsuits that make us want to shout “insane!” I once read a 99-page statement of claim, personally prepared by the claimant, which droned on forever and sought damages in excess of $100 million against a list of some 50 defendants, including the Queen and the President of the United States. It had been filed in an Ontario court. Fortunately the court figured out how nuts the plaintiff was and tossed the whole case out. But, very few cases are thrown out because one or the other litigants is a bit off side. A genuine attempt to recover damages for negligence will be heard, even if the monetary demands are excessive. While courts will try to be reasonable in granting damages, we all know that settlements in the millions happen.

With that said, liability insurance levels are typically based on one of two criteria: The limitation placed on budgets and the allocation of what is available. More interesting is the defining of coverage amounts by using personal and/or corporate net asset bases as the guideline. Some factor, which can be totally arbitrary, is applied to the assets being protected and the amount of liability insurance is based on (and regularly adjusted to) those values.

Either way, insurance amounts are not always easy to decide on, and where they are totally “arbitrary” one should not be shy about buying a little extra. You never know when it might come in handy.