As seen on
How Does Business Insurance Work?
While running a business can be a great opportunity to earn money, find freedom, satisfy a need to be your own boss and even create jobs, it also creates exposure to many types of risk. You can be sued or face other financial losses due to accidents, damage or theft, for example. To mitigate these inherent risks, successful businesses use a variety of insurance products. Here's how they work.
Table of Contents
- What is business insurance?
- How do I choose an insurance provider?
- Where can I buy business insurance?
- What is a policy period?
- What is a limit of insurance?
- What is a claim?
- What is an excess?
- What is a certificate of insurance?
- Occurrence vs. Claims-made policy
- All Risks vs. Certain Risks policy
What is business insurance?
Business insurance is a risk management tool to help limit the risk of certain disasters and financial losses. Your business (the policyholder) signs a contract with an insurance company—this contract is called an 'insurance policy'. As part of the contract, your business pays a small amount of money (the premium) to an insurer—you can arrange to pay annually, upfront or in monthly installments (although businesses paying monthly usually incur finance charges to spread out the premium payments throughout the year).
The insurance company's obligation as part of the contract is to protect your company against financial losses if disasters, accidents or other perils covered by the contract occur.
The most common types of business insurance are liability insurance, commercial property insurance (including landlord insurance) and commercial vehicle insurance (including fleet insurance). In addition, there are many other types of business insurance that you can read about in our article 12 Popular Types of Business Insurance.
- Liability insurance covers your business if it's sued for causing injury, illness or damage.
- Commercial property insurance covers damage or loss of business property such as buildings, office equipment, and more
- Commercial vehicle insurance can cover loss, theft or damage to your business vehicles, as well as providing mandatory third party liability cover
Insurance is meant to protect your business when disaster strikes. Without the right insurance coverages in place, your business would need to pay for liability compensation payments, repairs to & replacement of business property, and other financial losses. This could cause a serious financial hardship for a company, even driving it out of business. Insurance can help mitigate these risks and keep you in business even if you face a serious peril.
Insurance is Essentially Pooling Risks
All insurance is based on the concept of risk pooling. Any one business could be devastated by the financial loss of one disaster, but by spreading the risk evenly across multiple businesses this risk becomes bearable—the premium is each insured entity's contribution to this shared risk. Essentially, in a given year the claims made by some insured businesses are covered by the premiums paid in by all the insured businesses.
While similar risks are pooled together by an insurance company, each business is unique and presents its own set of risks. That's why insurance premiums vary from business to business. Insurance companies have sophisticated financial models to determine how much risk a business adds to the group, thereby determining the necessary premium—the higher the perceived risk, the higher the premium.
How do I choose an insurance provider?
- Financial Strength: If an insurance company is weak financially they may not be able to pay out claims. As an insured entity, you rely on an insurance company being financially sound so they will be able to pay claims in case of disaster. To check the financial strength of an insurance company, check with one or more of the major credit rating agencies: Moody's, S&P, Fitch or AM Best. They provide letter grades rating the financial strength of company, which can indicate the ability of an insurance underwriter to pay out claims to cover your losses.
- Customer Service Reputation: How easy is it to reach customer service? What's the claims process like? What's the renewal process like? How do you make updates to your policy like a change of address? Some insurance companies invest more in customer service call centres and technology that can make a big difference to your experience. To get a handle on an insurance company's customer service, check genuine customer reviews from sites like TrustPilot and Reviews.co.uk—if you use a broker, check results for both the broker and the underwriter of your policy.
- Value: Each insurance company has its own model for pricing risk. And each insurance company has its own portfolio to manage (e.g., is the insurer eager to expand their professional indemnity insurance portfolio, or reduce it?). As a result you might find very different pricing across insurance companies in the marketplace. There is no 'cheapest business insurance' so you'll have to compare the market or work with a broker or comparison engine to find the best deal for your business. And it's not always about price anyway—take into account how policies differ in terms of extra features (e.g., breakdown cover for a commercial vehicle policy) or the excess.
Where can I buy business insurance?
You have a few choices for purchasing business insurance in the UK marketplace:
- Buying direct from an insurance company: You can go directly to a company like Direct Line or AXA for business insurance without using a broker or comparison site. There are pros and cons to buying direct. For example, you can end up overpaying if you only get one quote from one insurance provider without comparing the market. And finding alternative quotes from different insurance companies directly can be time consuming. Also, not all insurance companies will cover all scenarios, especially at an attractive price. That said, you can sometime pay less because there are no commissions being paid.
- Buying direct from a broker: Brokers are independent companies that represent your business to find insurance for you. The broker takes your details and obtains quotes from suitable insurance companies, which can save you time and can be especially helpful for those with tricky insurance needs. Specialist business insurance brokers can be particularly useful if you're having trouble finding insurance elsewhere. There is one drawback of using a broker—higher admin fees. They typically charge a fee to arrange your cover; and if you want to cancel your policy mid term you're likely to pay a cancellation fee to the broker (as well as the insurance provider).
- Buying via a comparison site: Comparison sites use their search engines to connect you with suitable insurance providers for your needs. Some comparison engines are able to provide online quotes, enabling you to complete your business insurance purchase online with no human contact if you so desire. Other comparison engines send your details along to insurance providers that could be a good match; these companies would then contact you to finish your quote and purchase.
What is a period of insurance?
A period of insurance is the length of time that an insurance contract is valid. Generally speaking, most business insurance policies are one year long, and need to be renewed annually. When it's time to renew, your insurance company might increase (or decrease) your premium. Or they might not offer you a renewal. This can happen if your profile changes and the insurance company reassesses the risk of insuring your business, for instance. Alternatively, an insurance company might not renew based on their own internal risk assessment, for example if they are cutting back on offering certain types of business insurance.
You should hear from your insurance company a few weeks in advance of your renewal, giving you time to compare prices in the market or source alternative cover if the company does not offer you a renewal.
Can I cancel my business insurance?
During the period of insurance, you can cancel your business insurance if you no longer need it. There is typically an administrative charge for doing so, which might be higher if you've used a broker because both the broker and the insurance provider can charge a cancellation fee.
If you've paid your insurance premium upfront (i.e., you pay annually) then you will be entitled to a refund. Sometimes the refund is calculated on a pro-rata basis, which essentially means that each month costs the same amount and you only pay for the time from your start date until the cancellation date. For example, if you have three months (25% of a year) left in your period of insurance as of the cancellation date you'd get 25% of your premium back (less admin charges). However, some insurers refund a smaller proportion of the premium than a pro-rata amount.
|Refund when cancelling business insurance, assuming a pro-rata calculation|
|Original annual premium (paid upfront)||£1,000|
|Time remaining in the policy year at cancellation||3 months (or 25% of the policy year)|
|Refund on the premium||£250 (or 25% of the premium)|
|Cancellation admin charges||£30|
|Refund due||£220 (£250 less £30)|
If you pay for your business insurance monthly, then you'll typically need to continue paying until you've settled up according to the terms of the agreement. If a company does not follow a pro-rata structure then you might need to make a final payment reflecting the additional amount owed to the insurer, even if you're stopping cover.
What is a limit of insurance?
A limit of insurance is the maximum amount an insurance company will pay out for claims during the period of insurance. Some policies are written with a limit per occurrence (that is, per disaster or accident) and other policies are written with a limit in aggregate per policy year (that is, a maximum they'll pay out in the period of insurance across all claims).
For example, if your business insurance has a 'per occurrence' limit of £1 million and an aggregate limit of £2 million, the most it would pay for one disaster is £1 million. If you have multiple disasters in one year, the most the insurer will pay across all disasters is £2 million.
The limit of insurance is typically something you'll be aware of when you buy a policy, especially for certain types of insurance. For instance, employers' liability insurance is sold with a minimum of £5 million of cover (the minimum amount required by law). Other types of business insurance such as public liability insurance or business contents insurance have highly variable limits depending on your needs. Generally speaking, the higher the limits the higher the premium.
What is a claim?
A claim is when you ask the insurance company to pay for a loss that is covered by your insurance policy. When a disaster, accident or other event occurs, it's critical to formally notify your insurance company ASAP. Insurers may not honour otherwise valid claims if they're not made in a timely fashion. You can check your policy wording to see if there's a specific time limit for claims with your insurer.
What is an excess?
The excess is an amount you must contribute towards a claim before the insurance company covers their share of your loss. Essentially, you and the insurer both pitch in to cover losses that are covered by your insurance—you pay the excess and they pay the rest (up to the limit of cover).
For example, if you have a £3,000 claim on your business insurance and a £500 deductible, then you pay £500 of the loss and the insurance company pays the remaining £2,500.
Why is there an excess? The excess motivates a business to take measures to avoid situations that could lead to a loss and subsequent claim. It also helps to lower the insurance premium. In some cases you can opt for a higher excess in order to pay a lower insurance premium, but often the economics of doing so are not worthwhile (that is, a significantly higher excess typically reduces the premium by a relatively small amount).
What is a certificate of insurance?
A certificate of insurance (COI) is a document proving the existence of a valid insurance policy. A COI lists the policy's type of cover and effective dates, among other things, and is supplied by your broker or insurance company. Third parties may request to see a COI to prove you have adequate coverage in place; likewise there may be circumstances under which you want to see another party's COI. Read more in our article What is a certificate of insurance?
Claims Occurring vs. Claims made Policies
What happens if a claimable event occurs during the period of insurance, but is only discovered after the policy has ended—will this be covered?
If you keep renewing your policy, then previous events are typically covered (so long as you notify the insurer as soon as you know about the claim). But if you've let a policy lapse or gone to another insurer then you might not be covered—it depends on whether your insurance is written on an 'occurrence' or 'claims-made' basis.
Claims made policies cover claims only if the insurer is notified while the insurance policy is still active. This means you're not covered if you discover an incident after the policy ends—even if the exposure occurred while the policy was active. For example, consider accountant professional indemnity insurance. If an accountant's client suffers losses in 2020 and the accountant drops insurance coverage at the end of the year, the accountant is not protected if the client sues the accountant in 2021. This is important because a third party might not discover wrongdoing and submit a claim until years after the alleged act or decision. If a policy expires or is cancelled, it won't offer any more cover—even if the incident in question occurred while a policy was active. (This is why run-off cover is so important.)
Claims occurring policies will cover exposure that happened during the period of insurance, even if a claim is filed after the insurance policy has lapsed or not renewed. For example, if a commercial garden company builds on a multi-million pound project and has insurance when they deliver the project, but they're sued years later for the product they delivered, an occurrence-based policy would cover this risk. Occurrence-based ensures you're insured both at the time of the alleged incident (at the time of the act or decision) and also when a claim is made.
Certain business liability insurances like professional indemnity and D&O tend to be claims made policies, while employers' liability and public liability tend to be claims occurring. You can read more in our article Claims Made vs. Claims Occurring Business Insurance.
All Risks vs. Certain Risks policy
Business insurance can be written on an 'all risks' or 'certain risks' basis.
All risks policies cover the insured for all perils—except those specifically excluded in the policy terms. Exclusions vary by the type of business insurance, but can include defective property or intentional acts. All risks policies cover a larger number of possible loss events, so they can cost more.
When it comes to tradesman insurance, 'all risks' policies refer to comprehensive insurance that typically covers public liability, employers' liability and contract works.
Certain risks policies cover the insured for named perils, like fire, flood or theft. They will only cover losses where a loss is due to the named perils. Many types of business insurance such as commercial property insurance are written as certain risks policies.