Sorry, no coverage: How to understand commercial insurance policies

How insurance companies operate

Insurance is a core service for economic prosperity. Without insurance coverage to protect businesses in the case of major losses, many would not survive. Insurance supports entrepreneurship and has been shown to be a building block of emerging economies. Although most of the insurance industry is for-profit, insurers often collect fewer premiums than they payout in claim expenses. To sustain operations, pay out claims, and maintain adequate capital/administrative costs, insurers must use a business model that supports profit or else not survive. As shown in Figure 1, insurers are often only profitable due to income from investing those premiums.

Figure 1

So, which risks are insurable and which are excluded? The risk of loss must be definite in time, place, and amount in order to be deemed measurable and accidental. Loss exposures that are not definite would mean no coverage if the loss amount was overly subjective or speculative. As an example, general liability policies typically only cover losses due to bodily injury or property damage that can be documented. Insurance is about making one whole, restoring one to their pre-loss condition. The loss must be accidental, or losses to insurers would be monumental. If the loss was not an accident, it could be intentional, or it could leave the door open to policyholders misusing their coverage. In insurance, this is referred to as a moral hazard. For this reason, you will see exclusions like wear and tear on property policies. If you fail to take care of wear and tear and it causes a loss, you cannot recoup that loss.

Another major category of loss you will not see covered are losses that are likely to affect a large population at the same time, such as exclusions for terrorism and floods in coastal areas. This ties into losses that are simply deemed too costly to insure, like war. Determining whether there is coverage can be complex, so relying on an insurance professional for coverage analysis is critical. For example, some homeowners in Haines, Alaska, were surprised to find they had no coverage when a mudslide demolished their homes. However, if that mudslide were caused by a fire, the loss would have been covered. Similarly, mold is a common exclusion on property policies. But in some cases, coverage may be provided if the mold is caused by a covered peril. Policy language is critical in determining the application of coverage at the time of a loss. As a consumer, it is important to understand what is and what is not covered.

How to read your policy

A general understanding of insurance principles can help you glean the basics of what is and is not covered. Still, confusion can occur as many insurance policies are not written simply. While lengthy, it is advisable to read the entire policy. A helpful tip to review the basics of your coverage is to examine the policy sections using the acronym DICE: Declarations, Insurance agreement, Conditions, and Exclusions.

Declarations: Here you will find locations covered, limits of insurance by coverage type, deductibles, the name of who is insured, and premium depending on the type of policy.

Insurance agreement: Usually found at the beginning of your policy, this states what the insurer agrees to cover before exclusions are applied.

Conditions: These are often lengthy and will vary depending on the coverage type. Policy conditions are obligations or duties that the insurer and the insured must adhere to, or else they have the potential to prevent coverage. A well-known condition is the list of duties in the event of loss such as timely notification.

Exclusions: After reading through the other sections, a list of what is excluded will modify the coverage and usually supersedes any coverage that was implied or not limited prior to the exclusions section. These are often standard by coverage line, but some exclusions can be removed or altered by request or at additional cost.

This is a limited but quick way to review your policy. However, it is important to consult an insurance professional who can point out any significant coverage exclusions or differences in coverage from year to year. Insurance professionals should be able to answer any questions or concerns you have about what risks may not be covered or have limited coverage. These items should be discussed before a claim arises and coverage comes into question.

Coverage gaps

Consumers may be unaware of coverage gaps that exist in commercial policies. Common examples include named insured errors, property valuation, and additional insured status:

• All policies should have a clear specification of who the first named insured is on the declarations page. First named insured is different than a named insured with special rights and responsibilities as the primary policyholder. It is also important to include subsidiaries and legal entities as insured where coverage is required.
• Property should have adequate limits and the proper documentation to verify cost and value. All locations need to be considered for inclusion to avoid coverage denials or reduced limit availability. Flood, earthquake, and property in transit are common exclusions to look out for in property policies. Inland marine policies can fill coverage gaps for property in transit, at temporary locations, or where coverage may be limited or unavailable in traditional property policies. Replacement cost valuation should be considered rather than actual cash value to maximize recovery for a physical damage loss.
• General liability policies sometimes fail to include required coverage for additional insured as per contract terms, which can be addressed by endorsement. Joint ventures and newly acquired companies can result in coverage limitations if not properly addressed by endorsement. General liability policies do not provide adequate protection for exposure such as errors and omissions or environmental liability. These are just a few examples that can result in an unexpected and uninsured loss; customers should fully understand what risks are at stake and analyze the cost of insuring such risks against the benefits.

How to deal with residual risk

Risk of loss that is left over after insurance coverage is applied is called residual risk. Organizations can use a variety of means to protect themselves. Methods for reducing residual risk include avoidance, transfer, mitigation, segregation, and acceptance.

Enterprise Risk Management (ERM) is a great option for preparing for situations where insurance coverage does not apply. This proactive framework involves identifying and evaluating the various risks that could cause an organization to go out of business or fall short of strategic objectives. It is a broad and continuous review of uncertainties in all areas of operation, not just losses related to property and bodily injury. ERM manages risks that are cross-functional, such as technology risk, legal risk, and human capital risk. Risk can be in the form of a potentially negative outcome or a missed opportunity. ERM can assist an organization in preserving value, improving communication, meeting compliance, promoting risk awareness, and supporting duty of care.

It has become apparent because of the recent pandemic and increasing natural disasters that organizations need to pay more attention to risk stemming from events that are low frequency but high severity. This should include a plan for communication, life safety, asset protection, catastrophic risk insurance evaluation, and community involvement. Communication plans should include internal (all employees, leadership, stakeholders) and external (customers, suppliers, services) components. Consider delegation of responsibilities through establishing a leadership chain of command. Contact information should be up to date for emergency alerts to employees and notifications to customers and suppliers over delays and service interruptions.

A life safety plan should include emergency drills for events—such as fire, earthquake, tornados, and active shooters—and identifying shelter in place locations for employees. A business continuity plan should be in place prior to a disaster. This can include establishing a secondary location using a pre-arranged contract, ensuring redundancy of operations (including the ability to pay staff), and purchasing an emergency generator and essential life-supporting supplies.

Protect your premises with an updated list of assets including:

• Property identifiers (location/site and building detail)
• GPS coordinates
• Dollar value
• Addresses
• Year of construction
• Type of construction
• Location use
• Maintenance records

Commercial insurance coverage should be reviewed for catastrophic coverage including the possibility of earthquake, flood, windstorm, fire and pandemics. In addition, organizations should consider coordination with community partners like local fire departments, emergency management offices, police departments, and private or non-profits aid agencies. Insurance professionals such as underwriters, brokers, and consultants have critical roles to play in assisting clients with understanding risk and how to manage it efficiently. Taking the time to communicate with clients regularly in plain language will enable them to protect themselves. Coverage basics should be explained prior to a loss so that claims can be managed proactively. Exposures that are specific to the organization should be reviewed in depth. Clients should be kept informed on non-traditional risk transfers (such as ERM, captives, virtual captives, pools, large deductible plans, limit analysis, cost of risk, and market research) as needed.

Proactive protection

In an ideal world, no one would be surprised to find out the insurance they purchased does not cover the loss sustained—and they would have back-up plans for mitigating uninsured losses to reduce the negative impact. Insurance is not a one-size-fits-all approach. As increasing numbers of people and assets are exposed to risk, mutual understanding of creative solutions must be at the forefront. This requires collaboration and partnerships between insurance consumers and those who provide them with this critical product.

Insurance insiders have a duty to provide clear explanations of what consumers are purchasing and what risk is left over. Each state in the U.S. has an insurance commission, but these regulatory bodies focus mainly on issues such as fraud and bad faith rather than requiring insurers to provide timely information explaining what coverage they have and what deductible and limits are appropriate. Unequal access to information means the industry is often misunderstood.

The insurance industry benefits from improved consumer perceptions that will result in less insurance-related fraud and higher client satisfaction. More research and conversations are needed on current trends of consumer perception of insurance, especially regarding the kinds of failed communication mentioned here. With a clear understanding of how insurance operates and what coverage is appropriate, consumers can be proactive in protecting themselves through a holistic and diversified approach to managing risk.