When I present seminars on the topic of “Asset Protection,” a common question I hear is “now that I am incorporated, should I cancel my insurance?” To the other extreme, a common remark made by ignorant tax professionals and attorneys is, “don't bother with corporations, just buy a lot of insurance.” Both of these approaches are dangerous.
Insurance should never be overlooked as a means of protection. Insurance will cover many claims of a “tortious” nature (slip & fall, negligence, etc). The fact that you have insurance to cover these types of claims will help if your corporation is undercapitalized. If you do not have insurance and someone who is injured sues your “shell” corporation, then a court may think you were not “playing fair.” This is particularly important if your business is engaged in activities that are dangerous or hazardous to the public.
Insurance will not typically cover breach of contract claims, but courts are less likely to set aside a corporation for these types of debts. However, claims such as sexual harassment, employment discrimination, wrongful termination and fraud are almost never covered by insurance.
Another benefit of insurance is that the duty of an insurance company to “defend” (pay for your legal defense) is much broader than its duty to “indemnify” (pay for a judgment against you). Legal fees alone can be painful, especially for frivolous lawsuits, even if you win in court. They rarely award the defending party legal fees and the plaintiff's lawyer is often working on a contingent-fee basis, so that the plaintiff himself has nothing to lose by suing your company (have you ever heard the expression, “never get into a fight with an ugly person because he has nothing to lose?”).
The following is a brief summary of available insurance for your protection:
General Business Liability Insurance
This type of insurance can be reasonable and will cover a wide range of lawsuits from personal injury claims to copyright violations. Obviously, the higher the deductible, the cheaper the insurance. It may be worthwhile to keep an insurance policy with a large deductible and high limits to substitute for having to keep excess capital in your corporation.
Lawyers, doctors, engineers, architects, real estate brokers and other professional can obtain malpractice or “errors & omissions” insurance. This insurance covers goof ups that you and your employees make in dealing with clients. This insurance can be very expensive, depending upon the kind of business which you are involved. In addition, the coverage is weak because the policies are often “claims made”; that is, it only covers claims made in the year the policy is in effect. Regular liability insurance will cover you if you are sued years later for events that occurred during the policy period. In many states, the statute of limitations for malpractice is six years, so a lawsuit years later will not be covered if you do not maintain continuous coverage.
Director Liability Insurance
Director liability can be so precarious that many people refuse to serve on the board of any corporation without director liability insurance. This insurance is expensive and may not be necessary for a small corporation.
Umbrella Liability Insurance
An umbrella policy is one that kicks in after all other underlying coverage is exhausted. For example, if you have a general liability policy with $100,000 and a judgment is rendered against your corporation for $500,000, the umbrella policy kicks in the extra $400,000. Umbrella insurance does not cover other claims that are otherwise not insured (e.g., breach of contract claim). Most insurance companies require that you maintain all of your insurance with their company before they will issue an umbrella policy. Umbrella policies are quite reasonable, and can cover your business for up to several million dollars.
Extended Homeowner's Insurance
A typical homeowner's policy will cover basic liability claims against you regarding the property. It will not cover general liability claims unrelated to your property. For example, if you injure another while riding your jetski on a nearby lake, this claim will not be covered unless your homeowner's policy has a special endorsement. Review your policies with your insurance agent as to coverage issues and policy limits. If cost is an issue, increase your deductible. A lower deductible on a policy is general more expensive than a higher coverage limit for liability.