Insurance and Risk Management

Entrepreneurs & Their Communities December 26, 2007|Print

Risk Management may sound like a process that involves statistical analysis and complex algorithms but in reality we all practice some form of risk management every day of our lives. Risk Management is defined as the process of analyzing exposure to risk and determining how to best handle such exposure. When we cross the street a prudent person looks both ways and determines what point in traffic he can cross without risking himself any bodily harm. Local municipalities are participating in risk management when they develop disaster preparedness plans. When a business implements a risk management strategy it not only must consider physical risks to people and property but it must also address the economic risks associated with a market downturn or negligent behavior by the business itself.

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Insurance

Insurance is logical first step to managing the risks of a small business. In some cases it is up to the businesses to decide which types of insurance are needed to give the business peace of mind but in many cases a business must purchase insurance because it is mandated by law or required by funders. Insurance for small businesses include but are not limited to the following:

  • Property Insurance- Property insurance protects a business in the event of any physical damage to business assets. Property insurance is not only prudent but will be expected by lenders or lessors as a way to protect their financial interest.
  • Liability Insurance- Liability insurance protects the business in the event that the business in some way is responsible for or contributed to physical damage to property or bodily injury of others. This risk exposure to businesses in this country in the event of a lawsuit is significant and consequently, liability insurance should be a high priority investment for any business. This is also a type of insurance that is typically required by a lender.
  • Workers Compensation- This form of insurance covers employees of a business when on the job injuries occur. Workers Compensation Insurance is required by every state although the manner in which it is administered varies from state to state. To learn more about Workers Compensation in your state refer to a Directory of Workers Compensation Administrators can be found at [1]
  • Unemployment Insurance – Unemployment insurance is another form of insurance that is mandated by law and is maintained through contributions by all businesses with employees although a few states do require a nominal contribution from employees. Unemployment insurance provides benefits to employees who have been displaced from their jobs through no fault of their own. Although unemployment insurance does not mitigate risk to the business owner it is included in this publication because it required form of insurance that every business owner should be aware of. To contact the agency that is responsible for unemployment insurance in your state visit [2]
  • Business Interruption Insurance- Business interruption insurance defrays the impact of the downtime fro a business that is associated with disasters or property damage to complement the insurance that a business would carry to protect the business assets. An example of a situation where business interruption would be useful is a fire on the premises of the business that force the business to shutdown for an extended period of time. The insurance would make up for loss of income during that time.

Legal Entities

The form of business ownership will impact the degree of risk that a business owner and the businesses principals are exposed to. The simplest form of ownership is a sole proprietorship, however, the owner of the business can be held liable for the activities and debts of the business in a way that puts all of the owner’s personal assets at risk. Partnerships are also limited in their ability to protect the assets of the partner owners. Corporations, S Corporations and Limited Liability Corporations (LLC’s) protect business owners and the principals of the business from personally being sued or from personally being held responsible for the debts that accrue from the business. Limited partnerships will provide protection to investors or limited partners but the general partners have a similar exposure to risk as a sole proprietor or business owner engaged in a partnership. As is the case with any legal matter related to business it is always wise to work with an attorney to decide the form of business ownership that is the best fit for your enterprise.

Management Strategies

Perhaps the best practice for limiting or managing risk exposure to a business is to simply anticipate and plan for all bad outcomes. If your business relies on one particular vendor or employee how would you handle the loss of that particular person? If your business’ success depends on a unique innovations or concepts, have you taken the steps to protect that innovation otherwise called intellectual property from pirating by the competition? Trademarks, patents and copyrights are all forms of intellectual property protection that are ways to legally protect a business’ proprietary ideas. Computer networks and the Internet represent a host of issues that require some sort of risk management plan. Is the information located on your computer network backed up adequately? If you are among the growing number of web based enterprise it is important to prevent any interruption to business due to server failures. Think, also, about how you will protect yourself from credit card fraud and provide security for your client’s personal and financial information.

No business should expect 100% protection from all bad outcomes. The process for managing risks should always involve weighing the likelihood of the bad outcome against the cost of preventing that event. Risks in business are unavoidable. The key is to minimize their impact to the enterprise.

Prepared by Dar Knipe, University of Illinois

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