Question 1: You are given $1000 cash and have to choose one of the two options below, which would you choose?

Option 1 (Take a Risk) – Flip a coin. If its heads you get $1000 more and if its tails you get $0 more

Option 2 (Play it Safe) – You automatically get an extra $500

Question 2 – You are given $2000 cash and have to choose one of the two options below, which would you choose?

Option 1 (Take a Risk) – Flip a coin. If its heads you lose $1000 and if its tails you lose $0

Option 2 (Play it Safe) – You automatically lose $500

What option did you choose in each question? For Question 1 the majority of people chose Option 2 to play it safe and take the garanteed gain of $500. However, for Question 2 the majority of people chose Option 1 to take a risk of losing more in order to have of a chance of not losing anything.

The funny thing about the the study is that each question actually has the same possible outcome . Both questions give a 50/50 chance in Option 1 to end up with either $1000 or $2000 and Option 2 always guarantees $1500. So why did the majority of people switch their answer to take more risk in Questions 2 when the outcome is the same as Question 1?

It all has to do with how the question or situation is framed. When a situation is dealing with a potential gain (Question 1) people tend to ”Play it Safe”, however when a situation is dealing with potential loss (Question 2) people tend to “Take a Risk”.

This made me think how insurance is more like Question 2 because nothing can be gained by buying insurance. You either pay a premium and never use it (loss) or you use the insurance and it puts you back to the same position before the loss (no gain). The more important insurance implication is that people may be taking more risk without knowing it by either not buying insurance or not buying enough insurance. They look at insurance like Question 2 and tend to react using the Option 2 mindset of taking more risk in order to avoid an immediate financial loss (paying a premium).

Overall, I am not suggesting that you should handle risk by purchasing insurance for everything. However, when dealing with an insurance decision or any other loss situation,  beaware that loss aversion part of your brain could be influencing your decision.

So why did I reference monkey’s in the blog title? The study found that monkeys behave the same why as humans when they were presented with the same two questions but I’m not attempting to explain that one! View the entire presentation here “A Monkey Economy As Irrational As Ours” by Laure Santos.

Most small businesses have some idea about how organizing their business can reduce their liability. Many choose to either file their own corporate paperwork with the state or use one of the many pseudo-lawyer incorporation services available online or found in the “legal documents” section of an office store to save money. Granted, often the actual paperwork is not terribly complicated for a small business, but what these small business owners are missing out on is legal advice that they desperately need to ensure that their corporate identity survives an attack.

When properly filed and operated within certain parameters, corporations are considered to be separate entities. If a corporation does something that exposes it to liability, the corporation is the entity that takes the hit, the owner doesn’t have their personal assets on the line.

Consider this scenario: someone forms a corporation and goes out of town to present the business’s wares at a trade show. On route there is a car accident. Is the business liable for the accident or is the business owner personally liable? Similarly, consider what can happen if someone is harmed by a product the business sells; is the corporation he only entity liable or can the harmed product reach through to the owner’s personal property for compensation?

Generally, in either instance, the corporation is liable as a separate entity and the owners’ personal assets are unavailable to compensate a harmed party, however that isn’t always the case.

The act of setting aside the liability shield that a corporation provides is called “piercing the corporate veil,” and is more common than those selling incorporation kits care to mention. In fact, I’ve never encountered a corporation set up in such a manner that wasn’t at a high risk of losing its separate identity.

In Pennsylvania, there is a presumption against piercing the veil. In other words, it’s not an action a court takes lightly and, absent strong evidence to the contrary, the corporate shield will remain intact. That isn’t to say that it doesn’t happen. In fact, unless a harmed party is able to recover their damages entirely from the corporation one can be assured that an attempt to pierce the veil will be made.

The factors that a court will look at include: whether the corporation was sufficiently capitalized, whether corporate formalities were followed, whether there was a substantial intermingling of corporate and personal affairs, and whether the corporate structure was used to perpetuate a fraud. No single factor is normally going to be dispositive, although it can be.

The first two factors are usually tightly intertwined and many small corporations are under capitalized because there is such pervasive intermingling to personal and corporate affairs. In other words, many owners don’t treat the corporation like a truly separate entity. Some actions that can endanger the business owners along these lines include paying company debts out of a personal account, paying personal debts out of the corporate account, or keeping only a minimal amount in the corporation’s accounts. Also, it’s tempting to claim deductions for things purchased on a corporate account even when those things are destined for home use. All such actions are going to weaken the corporate shield.

Another common problem is that many small businesses, especially those with a single owner, completely ignoring corporate formalities such as holding meetings, keeping good records, having business plans, and conferring with tax or regulatory professionals as needed. It sounds silly that a corporation owned by a single person needs periodic meetings to discuss plans, but it should be done, even if there is only one person wearing all the hats, and detailed notes of these meeting should be retained. Lastly, some decide to form a corporation for nothing more than liability protection in the mistaken belief that doing so means that they can be save money on the appropriate insurances.

Those actions, alone or together, can lead a court to “pierce the corporate veil” and hold the owner personally liable for the debts of the corporation. If that happens, the initial money saved by foregoing appropriate legal advice and relying on an incorporate-yourself set of forms results in an anemic corporate form that gets brushed aside and the owners’ personal assets are available to compensate a harmed party. In such a case it’s probably better to have never formed a corporation since then the owner wouldn’t have the additional legal expenses from trying to defend an attack that the corporation won’t survive.

There are huge benefits to incorporating your business, make sure you take advantage of them.

Find other great blog articles for small businesses on Steve’s C3 Patent Law blog.

If you are a business with employees or a business that works with third parties (customers), you should become familiar with this acronym.   

Employment Practices Liability Insurance

Do you hire or fire employees?  Has anyone heard the latest “news” around the water cooler?  Do you perform employee reviews?  Do you provide raises or promotions?  Do you or your employees interact with customers or vendors?  Have you ever told a joke at work?

All of these things can lead to an Employment Practices claim.  What is an Employment Practices claim?  Any claim of actual or alleged abuse, harassment, failure to promote or provide a raise, inappropriate hiring or firing, the list goes on.

Lawsuits involving race, retaliation, and harassment make up the top three Employment Practices claims.  There are also lawsuits alleging wrongful termination, failure to promote, being offended by a joke…  You’re getting the picture.

Of course, many of these claims could prove to be groundless.  However, defense costs alone could end up costing major dollars, possibly up to $50,000.  Without Employment Practices Liability Insurance you could be left paying out of your own pocket.  Wouldn’t you rather dip into an insurance company’s pocket?

Studies show that it is more likely for your business to suffer an Employment Practices loss than a General Liability or even a Fire loss.  Are you prepared?

The Equal Employment Opportunity Commission website, www.eeoc.gov, has excellent information regarding laws and regulations pertaining to employers.  The Home Page even gives examples of recent lawsuits and how they were settled.  It’s an eye-opener!

Employment Practices Liabilty Insurance can provide you with the protection you need.  Limits can be purchased to include defense costs and claims brought against you by a third party, such as a vendor or customer.  You can also buy a policy that provides defense costs in addition to the coverage amount.  It’s not too late to find out if your insurance agent can provide you with this coverage.  It’s a call worth making, and it’s insurance worth buying.

Misconception 1: I Don’t Need Insurance because My Business is Too Small

Most people do not consider their hobby or part-time work from home as a business since it is not their main source of income. Thus, they do not even realize that they need insurance for a home based business. If you answer yes to the following 3 questions, you probably have a home based business along with all the risks and rewards associated with owning a business

- Is it a trade, profession, occupation or hobby

- Is it full-time, part-time or occasional

- Is the activity engaged in for money or any other type of compensation

Misconception 2: Doesn’t My Homeowners Insurance Cover My Home Based Business

Homeowners insurance policies were never intended to cover business exposures. The purpose of the homeowners policy is to protect insureds during personal activities. Neither the coverage nor the premium charged is intended to cover a business activity exposure. Thus, most homeowners insurance policies have very limited coverage for most home-based businesses. Below are the common business coverages and exclusions offered on most PA homeowners insurance policies

- No business liability coverage of any kind –no on-premises liability, no-off premises liability, no products liability, no professional liability, Workers Compensation liability, etc.

- No coverage on any detached structure, for example a shed or garage, if used even partly for to conduct business

- Minimal coverage on business property such as computers, fax machines, filing cabinets, tools and inventory – typically $2,500 in your home and only 10% or $250 away from home

What are My Insurance Options for a Home Based Business?

The insurance solution for a home based business is unique for each situation but most can be protected by using one of the following.

- Incidental Business Endorsement – Depending on the type of business and insurance company, you may be able to add an endorsement to your homeowners insurance to extend liability insurance for your home based business. This coverage usually costs around $30-$50 per year but it only covers on-premises business liability only.

- Businessowners Policy (BOP) – A BOP is a package policy that is designed to provide property and liability coverage for some small businesses. Generally, small businesses whose activities or operations involve processing and/or service are eligible for a BOP. Manufacturers, especially with complex liability issues, are not suited for a BOP. A BOP policy can cost as little as a few hundred dollars and it has several optional coverages that can be tailored to fit an individual business.

- In-Home Business Owner Policy – Some insurance companies offer a policy that combines a homeowner and BOP into a single policy and are designed specifically for home based businesses. The policies eliminate gaps and duplications in coverage and the rates reflect the in-home status of a business.

Don’t Risk A lot For A Little

Millions of Americans are operating a home based business without knowledge that they have little or no insurance protection. In the event of a loss, they could be underinsured or uninsured leaving them personally liable. The solution to reduce or eliminate this potentially devastating risk is simple and can cost as little as $30 per year. Don’t risk a lot for a little!

Are you sure if you are covered by home based business insurance?

Chad’s question on what is covered and more importantly not covered is one of the most important questions to ask when purchasing home insurance. Some people believe everything is covered for all reasons but home insurance policies have exclusions and coverage limitations. One example of those limitations are the 11 Special Limits for insuring your belongings (Coverage C). Note that the list below is based on a standard HO-3 home insurance policy and the Special Limits may be different for your specific insurance company. Make sure to check your policy or talk to your agent for the details of your policy.

1. $200 on money, bank notes, coins, precious metals, stored value cards and smart cards

2. $1500 on securities, accounts, deeds, evidences of debt, letters of credit, notes, manuscripts, personal records, passports, tickets and stamps (limit includes cost to research , replace or restore the information from the lost or damaged material)

3. $1500 on watercraft of all types, including trailers, furnishings, equipment and outboard engines or motors

4. $1500 on trailers or semitrailers not used with watercraft of all types

5. $1500 for loss by theft of jewelry, watches, furs, precious and semiprecious stones

6. $2500 for loss by theft of silverware, silver-plated ware, goldware, gold-plated ware, platinum ware, platinum-plated water and pewterware

7. $2500 for loss by theft of firearms and related equipment

8. $2500 on property, on “residence premises”, used primarily for “business” purposes

9. $500 on property, away from the “residence premises”, used primarily for “business” purposes.

10. $1500 on electronic apparatus and accessories, while in or upon a “motor vehicle”. Accessories include antennas, tapes, wires, records, discs or other media

11. $1500 on electronic apparatus and accessories used primarily for “business” while away from the “residence premises” and not in or upon a “motor vehicle”. Accessories include antennas, tapes, wires, records, discs or other media that can be used with any appartus described above.

Now you can see that these “Special Limits” might not be so special if you have an expensive engagement ring or a large amount of business property at home. Fortunately most of the these limitations can be resolved by either using non-insurance risk reduction methods outlined in our prior blog post or by purchasing the right insurance for an extra premium. The key is to be aware that these Special Limits exist so as your belongings change or increase, your insurance provides the coverage you expect. Also look for our future blog post dealing with the business property limitation listed above and other exposures that home-based businesses face.

Leave a comment below and let me know if you were surprised by any of the 11 “Special Limits”.

Claims May Add Surcharges

Most insurance carriers surcharge an existing homeowner insurance policy once a customer submits 2 or more paid claims in a 5 year period. Even if a policy has 2 paid claims costing $500 or 2 paid claims costing $50,000 in a 5 year period, the homeowner insurance policy will still have the same surcharge. Thus, before submitting a claim it is important to consider the estimated cost of a claim and how much your insurance carrier may surcharge the policy.

A CLUE Records All Claims

In a our prior blog post “Get A C.L.U.E – A Carfax Report for Houses”, we talked about how a CLUE report shows homeowner insurance claims on a property for the past 5 years. However, did you know that all homeowner insurance claims submitted to the insurance carrier are documented on a CLUE report regardless if the claim is paid or not. Thus, it is always good to talk with your insurance agent to understand if your claim is covered or excluded before it goes on a CLUE report for the next 5 years.

Claims Information Can be Available to Buyers

Home buyers and real estate agents can now get a CLUE report by requesting the seller to purchase a CLUE Home Seller’s Disclosure Report from Choicepoint. This special CLUE report removes all the personal information about the property owner but it still has the 5 year claims history. Thus, it is important to remember that submitting a homeowner insurance claim could impact a future real estate transaction.

Overall, submitting a homeowner insurance claim can be a very smart decision but make sure to consider all the implications of a claim with your agent before submitting one. Being surprised when your next homeowner insurance bill comes in the mail or when you try to sell your home is never a fun experience.

Many property insurance policies provide coverage on your computers if they burn in a fire or get stolen.  However, that policy probably does not provide coverage against computer viruses, or the coverage might be limited.

Some insurance companies offer a special kind of coverage designed specifically for risks inherent with computers.  It is often called “Electronic Data Processing (EDP).”  This coverage usually provides insurance against computer viruses.  But it also provides much more!

Computers can be susceptible to breaking down, either mechanically or electrically.  This could include malfunction, short circuit, blow-out, electrical or magnetic injury, or even accidental erasure of data caused by electrical or magnetic injury.  An EDP policy would normally provide coverage for these types of losses.  (Typically not covered is electrical damage which originates more than 1500 feet from your property.)

Also provided in a typical EDP form would be coverage on your portable computers, such as laptops, notebooks or handheld computers while away from your property.  This equipment may have limited coverage on your standard business insurance policy.

So, if your business depends on computers you may want to consider looking into whether your business insurance company can offer you this type of protection.

Think of it as a handkerchief for your PC.

We have all seen the car commercial where the guy is on the used car lot and says “Show me the CARFAX®” before he purchases a vehicle. A CARFAX® report provides potential buyers a vehicle’s history of ownership, titles and accidents. The report allows buyers to make an informed purchase decision and gives them confidence that they are buying what is advertised. Did you know the same type of report is available when you buy a house too?

What about something like CARFAX® for houses? The CARFAX® for a home is called a C.L.U.E.® or Comprehensive Loss Underwriting Exchange report. A C.L.U.E.® report shows insurance claims made on a property for the past 5 years and insurance companies use this information for underwriting homeowner insurance (See a C.L.U.E. example).

However, home buyers can also get a C.L.U.E.® report by requesting the seller to purchase a C.L.U.E. Home Seller’s Disclosure Report for $19.95. Remember that the buyer or real estate agent cannot order the C.L.U.E.® report and it only can be provided by the seller or owner. The report shows the same claim history on the property that insurance companies use but it removes all of the seller’s personal information that they would want to keep private.

If you wouldn’t buy a car without the CARFAX® report, should you buy a home without a C.L.U.E.® report? Let me know your thoughts.

To help determine if raising your car insurance deductible is a good financial decision, you need to analyze the payback period.  The payback period is how long it would take to buy back your deductible from insurance premium savings. It can be calculated in 4 simple steps and is best explained by using an example.

Assume that our friend Mr. Fancypants is paying $1000 per year for car insurance and he currently has a $250 collision deductible on his car. To save money, Mr. Fancypants wants to increases his collision deductible to $500 making his auto insurance drop to $900 per year. Is raising Mr. Fancypants collision deductible the most economical decision using the payback period method?

Step 1: Calculate Retained Risk – When you raise your deductible that means you will pay more out of your own pocket before the insurance policy starts to pay.  Originally Mr. Fancypants would pay the first $250 for a collision claim but raising his deductible means he would now pay the first $500. Thus, Mr. Fancypants is retaining $250 of additional risk by increasing his deductible. (Learn more about retained risk in our prior blog article)

New Deductible – Original Deductible = Additional Retained Risk
$500 – $250 = $250 (Additional Retained Risk)

Step 2: Calculate the Savings – Since Mr. Fancypants is retaining more risk, the car insurance policy goes down to $900 per year and he saves $100 per year.

Original Premium – New Premium = Savings per Year
$1000 – $900 = $100 (Savings per Year)

Step 3: Calculate Payback Period – The payback period in this example is how long Mr. Fancypants would have to drive without having a covered collision claim to make his money back. It is calculated by dividing his additional retained risk (Step 1) by the additional savings (Step 2) for raising his collision deductible.  For Mr. Fancypants, he would have to drive 2.5 years without a covered collision accident claim before he would make his money back from the savings on his policy.

Additional Retained Risk / Savings per Year = Payback Period (yrs)
$250/$100 = 2.5 years

Step 4: Compare Payback Period – Since Mr. Fancypants does not actually know how long he will drive without having a collision accident, he needs a guideline to help make a decision. A general rule of thumb is if the payback period is less than 4 or 5 years, it usually makes financial sense to increase your car insurance deductible. Since the payback period for Mr. Fancypants is 2.5 years, the payback period method suggests that he should raise his deductible.

Remember that the payback period is just one guideline for making the decision to raise your insurance deductibles. Other factors to consider would include your likelihood to submit a car insurance claim, if you have the cash to pay the higher deductible and your prior driving record just to name a few.

Have you used the payback period to determine if your car insurance deductible are the most economical? Leave a comment below.