Business Insurance as a Part of Risk Mitigation

Dr. Earl R. Smith II
Managing Partner, The Federal Circle
DrSmith@Dr-Smith.com
Dr-Smith.com

Investors and shareholders need to make sure that major business risks are covered. Failure to do so can result in major losses.

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Business risk too often is defined very narrowly and only in the context of the business plan and establishing credit. Business risk is much broader extending to probable material effects of events on a businesses’ ability to achieve established strategic goals. Professional governance will be concerned with business risk in the broadest sense and establish strategic plans to identify and mitigate risk.

Business risk will vary by industry group. Each operating unit of a company will have unique challenges and risk associated with the individual business unit. The board of directors should be concerned with the overall risk to the business and the impact a particular event could have on the company as a whole. Some of the common risk businesses’ face includes:

• Natural disaster
• Customer or employee accidents
• Product liability
• Embezzlement

Some risks associated with business are less obvious but can have a devastating effect on a company’s ability to continue to operate. Some of these less obvious risk events are:

• Supplier bankruptcy
• Loss of reputation
• War
• Unexpected new product introduced to market

The board of directors will often engage an adviser to assist the board with establishing criteria for a systemic risk management program. Most risk programs will start with an assessment of potential risk events. Risk events are events in which the company may not be able to avoid, but which if occurred could have a major impact on the company as a whole. Typically, risk events are assigned a number from 1 to 5 with 1 being unlikely to occur and 5 being almost certain to occur at some point in the future. Advisers can assist the board by adding their broad experience to the assessment of risk.

Risk assessment also must consider the potential impact a particular risk event will have on the business should it occur. Not all risk will be treated the same. If the impact of a particular risk event is not large enough to have a systemic impact on the company’s ability to deliver its goods and services is may not need to be part of the company’s risk management program even if the risk event is likely to occur.

Identifying risk events is the first step in developing a risk management program and assessing the impact is the second. The third step is to develop a mitigation plan. Risk mitigation involves a strategic plan to reduce a company’s exposure to a particular risk event. Specifically, a mitigation plan should reduce the impact the event will have on the company should it occur. A major component of risk mitigation is by covering as much of the company’s exposure as possible with appropriate insurance cover.

There are several types of insurance a board of directors should consider as part of a thorough mitigation plan, including:

• Errors and Omissions insurance
• Officers and Directors insurance
• General Liability insurance
• “Key Man” insurance

Each type of insurance covers a particular risk. Directors should carefully read and understand the policies and pay particular attention to all definitions, exclusions and coverage limits. Directors should certainly engage a lawyer or an independent insurance specialist to explain in detail any part of the policy. Insurance companies will often provide standard insurance policies that can be tailored with additional coverage or fewer exclusions for additional costs to the consumer. Companies should not assume particular events are covered. A business general liability insurance policy will not cover an automobile accident involving a delivery truck.

Whether the organization is not-for-profit, or for profit the function of the company’s leadership is to manage all aspects of the company including risk. Any risk management plan will attempt to lower exposure while mitigation will attempt to lower the impact a risk event will have on the company as a whole.

© Dr. Earl R. Smith II

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Related Articles:

• Boards, Leadership, Governance and Risk
• Risk Governance – Managing Safe Companies
• Directors and Officers Insurance
• Errors and Omissions Insurance – Necessary Protection of Officers and Directors
• Governance and Risk Management Strategic Plans
• Corporate Risk Management

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