September/October 1988
Do you have questions about your business insurance? So do other scrap processors. For some clear, informative answers, read on.
By David M. Wassum
David M. Wassum is director of risk management for the Institute of Scrap Recycling Industries, Washington, D.C.
Business insurance, while complex by nature, doesn't have to be confusing. If you know the details about particular types of insurance coverages, understand how to tailor coverage to your needs, and are familiar with some of the legal issues surrounding the insurance industry, you can make intelligent decisions about purchasing your business insurance.
The information that follows will help you make appropriate choices about protecting your operation.
Covering Property Loss
Purchasers of business insurance need to know the difference between two types of property coverage: "all-risk" or "named-perils." A named-perils policy spells out exactly what type of loss is covered (e.g., from fire, lightning, or wind). Damage arising from any other cause is not covered. In contrast, an all-risk policy spells out what type of loss would not be covered. Generally, the all-risk policy provides an insured with broader coverage--but it is extremely important that buyers of all-risk policies closely examine the policy exclusions to determine exactly what types of losses are not covered.
Potential insurance buyers must also consider whether to purchase coverage on an actual cash value or a replacement cost basis. Actual cash value coverage is based on the cost to repair or replace damaged property, less physical depreciation. Replacement cost coverage is designed to repair or replace damaged property without regard to physical depreciation.
The concept of coinsurance is frequently misunderstood. Coinsurance is an agreement by which the person purchasing insurance agrees to maintain insurance coverage equal to a given percentage (usually 80 percent) of the value of the insured property in exchange for a rate reduction. Most property coverage is written subject to a coinsurance requirement. The importance of understanding this concept becomes evident when a potential loss is considered.
For example, if property valued at $100,000 is insured subject to a coinsurance clause, the insured party agrees to maintain insurance in the amount of at least $80,000. In case of a partial loss (e.g., $50,000), the policy would pay for the entire loss (less any applicable depreciation). However, if the insured fails to maintain coverage of at least 80 percent, the insured would share in the cost of any subsequent loss. The basic formula to be used in calculating the amounts paid under a coinsurance clause is:
Amount of insurance carried/amount of insurance required x amount of loss = amount paid.
To illustrate, if property valued at $100,000 is insured for $80,000, any loss up to $80,000 would be paid in full. However, if the property is insured for only $40,000, only 50 percent of any partial loss would be covered. In both cases, any loss greater than $80,000 would be uninsured.
Because of the coinsurance clause, it is very important that accurate values be determined for property being insured. In addition, through use of an "agreed amount endorsement," insurance purchasers can obtain a measure of protection against unforeseen increases in property values that would otherwise subject the policy to coinsurance requirements.
A highly specialized type of property coverage, called "boiler and machinery insurance," while not always readily available for scrap processing operations, can be purchased to cover processing equipment subject to breakdown or other failure. For example, large electric motors that power equipment such as shredders can be insured under this type of policy. Only two companies are generally acknowledged to have the expertise necessary to underwrite this type of risk.
The majority of the premium charged for boiler and machinery coverage is assigned to cover the cost of a detailed inspection of the equipment to be insured. The primary purpose of the inspection is to prevent any loss which might be paid under the policy. As a result of this inspection, the insurance company may require significant changes in operating practices as a condition of insurance.
In addition to loss of property, insurance coverage can be purchased for "consequential losses" resulting from the loss of property. For example, if a critical building or piece of equipment is destroyed by a fire, a scrap operation would suffer losses beyond simple replacement of the item destroyed. Business interruption insurance would provide protection for the loss of profits and additional expenses that could result from a catastrophic loss.
You Can Control Your Premium Amount
Rates for property insurance are typically calculated by the Insurance Services Office (ISO), a central clearinghouse which serves the insurance industry. The insurance rate is determined based on the type of construction, the nature of the building contents, and the type of fire protection available for the community. To this pure rate must be added the insurance company's expenses and projected profits.
Liability insurance rates are established based on the type of industry and the type of laws for the various states or territories in which an insured business operates.
Rates may be further adjusted depending on characteristics of the company being insured. For example, a company with an effective loss control program and good management controls may be eligible for significant credits when its insurance premium is calculated. Alternatively, a poorly managed company with uncontrolled risks may be subject to substantial debits.
Likewise, through use of prudent deductibles and retention practices, a company can save substantial amounts on its insurance coverages and reap direct benefits from its loss control efforts.
Working Out Workers’ Comp
Workers' compensation insurance can be the greatest premium exposure for the typical scrap processing company. The typical policy consists of two parts. The actual workers' compensation coverage provides insurance for losses as mandated by state or federal law. In most cases, awards for work-related claims are determined based on a schedule of benefits as described in the particular state's compensation act.
The second portion of the typical workers' compensation policy covers employers' liability. This protection is critical to provide coverage in those instances where an employee seeks to recover damages for claims not covered by the state workers' compensation law, or in cases involving secondary losses resulting from work-related accidents (e.g., loss of consortium).
Several states require employers to participate in a monopolistic state fund which provides workers' compensation insurance. In many cases, the state fund does not provide supplementary employers' liability protection. Such coverage may be available through an endorsement to the company's general liability policy; it is important that this protection be secured.
Workers' compensation insurance is rated on the basis of payroll, with specific rates assigned to various job classifications and to operations a company may have in different states. Employers must verify that proper job classifications are identified in their policies. Significant premium variations can arise if employees are improperly classified.
Particularly in workers' compensation insurance, a company's loss experience plays a critical role in determining insurance premiums. Through a mechanism known as the "experience modifier," a company's basic insurance premium is directly adjusted to reflect that company's loss record developed during the previous three-year period. Thus, a company with a loss record much better than the industry average will obtain a substantial discount on its workers' compensation coverage, while a company with a poor loss record will pay a much higher premium.
Workers' compensation can also be written through a loss-sensitive plan or on a dividend basis, which permit the insured to share in savings attributable to a good loss record. Because of the advantages and disadvantages involved in securing this coverage, insurance buyers should fully explore with their agents the types of policies available, along with the costs and risks of each.
One potentially troublesome exposure may be faced by companies involved in operations on navigable waters, such as loading or unloading vessels or dismantling barges. Such operations may be subject to the federal Longshoremens' and Harbor Workers' Act, which generally provides higher benefits for work-related injuries than are provided under ordinary workers' compensation policies. Companies with potential exposures of this nature should have an endorsement added to their workers' compensation policies to cover such exposures. In addition, companies with incidental operations in several states should have an "other states" endorsement added to their policies to provide coverage for losses arising from such operations.
Companies can take several actions to save premium dollars on their workers' compensation policies. A company should check its experience modifier to verify that it is correct. Overtime payments to employees should be identified so that the amount of overtime pay can be discounted in the premium calculation. In addition, employers should obtain certificates of insurance from each subcontractor performing work for the company to avoid being charged additional premium for the subcontractor's operations.
Liability Coverage
In the area of liability coverage, it's important to understand not only the coverages afforded by the standard comprehensive general liability policy, but the exclusions as well. One of the most important exclusions from the scrap processors' perspective is the pollution exclusion.
Significantly, the ISRI-sponsored business insurance program underwritten by the CNA Insurance Companies bases liability premiums on payroll rather than on gross sales, which is the usual practice in the insurance industry. Since scrap prices can fluctuate considerably, liability premiums based on sales would also fluctuate dramatically without regard to underlying liability exposures. In all but a few states CNA has arranged to rate liability policies on the basis of payroll, a more stable basis for evaluation. In a few states, however, rating based on sales is specifically required. Product liability insurance is rated on the basis of sales only.
For additional protection beyond the limits of ordinary liability policies, most companies typically purchase an excess policy or an umbrella policy. There are important differences between the two. An excess policy simply provides additional layers of insurance coverage beyond those provided by the underlying policy. Any policy terms contained in the underlying policy are also included in the excess coverage.
An umbrella policy provides excess coverage as well as other exposures not covered by underlying policies. Umbrella policies can also offer full defense coverage, providing protection whenever the underlying policy's defense coverage expires or in cases where no defense protection is provided by the underlying policy.
To avoid questions about coverage, both the underlying policy and the umbrella policy should have the same effective and expiration dates of coverage.
It is particularly important in the case of excess or umbrella coverage to evaluate the stability of the insurance company writing the policy. Since coverage may not be triggered under such a policy for several years, the insurer must have adequate financial capability to respond.
Be Prepared
When shopping for insurance, it is most important to provide the prospective insurance company with a complete and accurate description of your firm's operations, including the bases of various desired coverages, values of property and equipment, and basis of coverage. For property coverages, you should specifically identify auxiliary exposures such as fences, signs, or antennas. To purchase business interruption insurance, you should complete a detailed worksheet including sales and non-continuing expenses to provide the basis for coverage. For automobile coverage, compile complete information about equipment operators and a schedule of equipment to be insured. Thorough information about your company's losses should also be available for evaluation.
How long should you retain your insurance policies? For property coverages, there is generally no need to retain policies beyond one year unless a claim is outstanding. Fidelity Policies ordinarily should be kept for three years after expiration. For workers compensation and liability coverages, because of the extremely long periods during which claims might arise, policies should be retained indefinitely.
A legal issue in the workers' compensation area that is presenting potential problems for scrap processors is the evolving area of "intentional" employer actions allegedly causing employee injuries. Suits alleging this type of claim have been filed in many cases in an attempt to collect damages outside the boundaries of normal workers' compensation coverage. In most situations, courts have narrowly construed workers' compensation laws to preclude this type of claim. In the state of Ohio, however, such claims have been upheld.
A key issue in determining insurance coverage under liability policies is the presence of a claim for bodily injury or property damage. For example, no insurance is provided for a load that is rejected by a consumer. "Breach of warranty" is generally not insurable. However, if a load is melted by the consumer and the material damages the melting furnace, coverage most likely would be provided under the company’s product liability policy for the furnace. In this case, actual "property damage" has occurred, thus triggering coverage.
As a scrap processor, you know what you want to protect. The proper insurance can give you the means to do it. Being aware of what is available to you, and how it can work for you, will put you that much closer to customizing an insurance policy that you can count on for years to come.
Do you have questions about your business insurance? So do other scrap processors. For some clear, informative answers, read on.