Financial Aspects of Insurance
In general, insurance for insurable risks falls into two broad groups: liability and casualty. Companies buy insurance to prevent financial impairment due to an action that would make the company liable to a third party. Companies also buy insurance to offset possible losses stemming from interference with operations. This latter is a wide-ranging classification, embracing work stoppages resulting from fire, flood, machinery breakdowns, labor difficulties, theft and bad credit risks.
The interrelationship between insurance needs and the financial health of a corporation is such that insurance is properly the responsibility of financial managers. It is a complex subject, involving financial and legal considerations. Large companies may have an insurance officer or a risk manager, as he sometimes is called. Smaller firms usually assign the task to a ranking member of the financial department.
Defining the Risks
Analyzing a company’s pssible exposure to risks which can be insured is not as easy as it may appear. The obvious perils are one thing. These include fire, burglary, accident, water damage, and the like.
Other risks are not so easily identified. Take the case of a display manufacturer who unknowingly uses inflammable materials for his designs. What is his liability if the materials cause cause a customer’s facility to catch fire? Or consider a firm that charters a vessel for an employee fishing party. If the boat sholud sinks, or if individuals are hurt or lost, is the company financially responsible?
The answer are not important here. But the examples serve to underline the fact that risk exposure covers a multitude of possibbilities. Right from the start, therefore, a business should analyze its possible liabilities and arrange for adequate coverage.
Insurance against operating losses should also be thoroughly investigated. A machine may break down, or a raw material may not be delivered on time. Production is set back, deliveries are delayed, and receipts are postponed. Revenue may be lost entirely if the customers seek another source of supply.
Naturally, not all possible perils can be foresee. Nor for that matter would a company deem it necessary to provide insurance for all the risks it could envision. In so far as it is practicable, the extent of possible loss or liability should be defined. Also, the chances for it occurring have to be considered. A company may be willing to take a calculated risk, weighing the cost of the insurance againts the eventuality of anything adverse happening. In short, probability plays a large role in determining what risks the company insures againts.
What Approach to Take
A program of risk analysis is not just confined to buying or not buying insurance. Whatever possible, the risk must be eliminated. Some exposures, of course, can’t possibly be controlled. For example, driver education and proper maintenance of vehicles can help measurably to reduce accidents. But they won’t eliminate them entirely, and so the potentialliability ca be great.
Management has a responsibility to correct all conditions which are potentially hazardous. Providing adequate coverage for perils should be viewed as a necessary but alternative function. The first step should always be to attempt to do away with the risk:failing that, the company should seek to controlit.
Insurance seldom covers the full extent of a loss. A company may recover substantially all the cost for brick and mortar and equipment for a facility gutted by fire. However, there are also the indirect costs involved. These may, in the long run, be far more expensive to the company. For example, the loss in profits due to the company’s inability to continue to operate won’t be recovered by the fire insurance policy. The company’s possible loss of position in the market is another factor. Also, necessary development work may have to be curtailed, leading to a future competitive disadvantage.
Types of Risk
The following are risks which a company generally faces:
- Damage or destruction of physical assets. Included in this classification are losses or damage suffrered to real or personal properties. Real property consists of land, buildings, and appendages such as elevators, furnaces and plumbing fixtures. Personal properties range from inventory to furniutre to vehicles. Standard coverages for such losses include fire, ocean marine, machinery breakdown and crime insurance.
- Losses affecting income. There are perils which, while causing physical damage, also adversely affect earning power, Businesses can obtain insurance which will cushion the effect of loss profits and help defray extra expenses if the business is such that oprations have to be carried on regardless. On a personal basis, insurance can also be used to provide income for the families of individuals who lose their live, or as compensation in the event of accidental injury, physical disability or sickness.
- Third party legal liability. A company may be responsible for personal injures and property damage to those outside its employ as well as those within it. This responsibility can prove to be especially serious because a liability award can be so large that it becomes a financial burden. Furthermore, the liabilityma y be incurred whether or not there was any negligence. And it may result from the action of a company’s agent