Have you reviewed your insurance policies lately? I recently read through the commercial policies we have for our firm. If you do the same, you will likely encounter many phrases similar to the ones below.
Do these sound familiar?
This insurance excludes loss, damage, cost or expense of whatsoever nature directly or indirectly caused by…War, invasion, acts of foreign enemies, hostilities or warlike operations (whether war be declared or not), civil war, rebellion, revolution, insurrection, civil commotion assuming the proportions of or amounting to an uprising, military or usurped power; or 2. any act of terrorism… use of force or violence and/or the threat thereof, of any person or group(s) of persons, whether acting alone or on behalf of or in connection with any organization(s) or government(s), committed for political, religious, ideological or similar purposes including the intention to influence any government and/or to put the public, or any section of the public, in fear.
Exclusions: Based upon, arising out of or resulting from a third party’s unauthorized access to an insured’s electronic or written documents, records or financial instruments.
This Policy* does not apply…to injury, sickness, disease, death or destruction (a) with respect to which an insured under the Policy is also an insured under a nuclear energy liability policy issued by Nuclear Energy Liability Insurance Association… or (b) resulting from the hazardous properties of nuclear material.
Exclusions: Caused by access to the Named Insured’s “Electronic Communications System” by any government, governmental agency or subagency, or any agents thereof while acting on behalf of such entity.
…due to riot, civil commotion, war, insurrection or usurped power.
…based upon or arising out of “Bodily Injury” or “Property Damage.”
…based upon or arising out of liability of others assumed by the Insured under any contract or agreement; provided, however, this exclusion shall not apply to liability an insured would have in the absence of such contract or agreement.
…brought by or on behalf of any employee, former employee or prospective employee based upon, arising out of, or in any way involving the employment relationship or the nature, terms or conditions of employment or any workplace tort.
…brought by, in the name of, or on behalf of any past or current principal, partner, officer, director, trustee, shareholder or employee of the Named Insured; provided, however, this exclusion shall not apply to any Claim arising out of “Unauthorized Access” or “Potential Unauthorized Access” to the personal information of any past or current principal, partner, officer, director, trustee, shareholder or employee of the Named Insured which is in the care, custody or control on the Named Insured.
…based upon or arising out of any warranties or guarantees, express, implied or otherwise, or any cost estimates.
…based upon or arising out of any conversion, misappropriation, commingling of or defalcation of funds or property.
…based upon or arising out of any inability or failure of any party to pay or collect monies.
…based upon or arising out of infringement or inducement of infringement of patent or trade secret.
…based upon, arising out of, or in any way involving an act, error or omission in the performance of professional services rendered or that should have been rendered by the Insured or by any person or organization for whose acts, error or omission the Insured is legally responsible.
…based upon or arising out of services performed by an insured acting as an accountant, attorney, real estate agent or real estate broker for which a separate fee is charged.
…based upon or arising out of any commingling or other use of client funds.
These are just some of the exclusions in our commercial insurance policy, and I left out many of the verbose exclusions (some are almost half a page). Clearly, this is an enormous list. In fact, exclusions in our Commercial General Liability insurance policy are labeled “A” through “S.” It’s worth noting that our business operates predominately in an office environment and is relatively simple. Imagine the policy exclusions for more complex businesses with more complicated operations.
In addition to exclusions, commercial insurers can easily drop your coverage. Below is an excerpt from our policy.
We may cancel this policy by mailing or delivering to the first Named Insured written notice of cancellation at least:
120 days before the effective date of cancellation if we cancel for any other reason.
This is a fairly obvious exercise, and it clearly demonstrates our commercial insurance policy is riddled with exclusions that create gaps in insurance coverage. We all know that life isn’t fair. There are countless cases where a business owner paid for commercial insurance for 10 or fifteen years only to face a loss that was excluded in the businesses insurance policy. It’s easy to say, “this won’t happen to me…” But, what if it does? How will it feel to have paid thousands of dollars in insurance premiums over the years… to find out your business isn’t covered when you really need it?
Rather than trying to fill most or all gaps in commercial insurance policies with additional – often costly – commercial policies, a better approach for many small and mid-size businesses is to blend third-party commercial insurance coverage with additional insurance coverage provided by a captive insurance company owned by the business or its owners. Captive policies are more flexible than commercial policies, have few or no exclusions and can be written to fill gaps. Importantly, they also avoid the “sunk cost” trade-off of commercial insurance.
This is another reason that small and mid-size businesses are increasingly using small captive insurance companies. Furthermore, there is good news for small businesses considering owning a captive to cover gaps. Congress explicitly incentivizes small businesses to do so by providing the 831(b) tax “benefit”.
An 831(b) tax election permits a Captive Insurance Company (usually owned by the business or the business owner) to retain underwriting profits in the event that claims caused by insuring gaps in coverage do not materialize. These profits can eventually be reinvested back into the business. Profits from insuring unrelated third parties (via participation in risk distribution pools) further reduce overall insurance costs to the business, and the pools themselves serve to diversify the business’ risks. Insurance policies obtained via the associated captive insurance company and risk pool can provide a blanket of coverage, filling commercial coverage gaps with the goal of better positioning the business for long term survival.