A company must determine the amount of risk that it is willing to undertake. When the board of directors attempts to quantify this, it frequently finds that it is uncomfortable with the level of risk that it currently has, and mandates more action, through new policies, that reduce the level of risk. The policies can include a number of risk management issues, such as the financial limits for risk assumption or retention, self-insurance parameters, the financial condition of insurance providers, and captive insurance companies. The policies do not have to cover some issues that are already required by law, such as workers’ compensation insurance. An example of a comprehensive insurance policy is noted below.
- ABC Company will obtain insurance only from companies with an A.M. Best rating of at least B++.
- All self-insurance plans will be covered by an umbrella policy that covers all losses exceeding $50,000.
- No insurance may be obtained from captive insurance companies.
- The company must always have current insurance for the following categories, and in the stated amounts:
- Director’s and officer’s insurance, $5 million.
- General liability insurance, $10 million.
- Commercial property insurance that matches the replacement cost of all structures and inventory.
- Business interruption insurance, sufficient for four months of operations.
There are several key points to consider in the preceding exhibit. First, a company may be tempted to purchase very inexpensive insurance, which typically comes from an insurance provider that is in poor financial condition. If the company subsequently files a claim on this insurance, it may find that the provider is not in a position to pay it. Consequently, the first policy item defines the minimum financial rating that an insurance provider must attain before the company will purchase insurance from it. Another is that a company wants to put a cap on the maximum amount of all risks that it is willing to tolerate, so that it cannot be blindsided by a large loss that is not covered by insurance. The second policy point, which requires a cap on self-insured risks, covers this problem. Finally, the Board may feel more comfortable defining the precise amount of insurance coverage needed in specific areas. Though the policy shows a few specific insurance amounts, it is usually better to define a formula for calculating the appropriate amount of insurance, such as commercial property insurance, that will cover the replacement cost of structures and inventory. This keeps the amount defined on the policy from becoming outdated due to changing business conditions. These are some of the most important insurance issues that a risk management policy should cover.