Today insurance is often seen as an unnecessary expense or it is purchased as a compliance requirement. Having in place the right insurance can provide a reliable source of capital to the business and SMEs can see it as part of their approach to properly finance operations. At the same time, they can increase the possibility of acquiring new capital for growth from financiers.
Insurance is one of those aspects of business that almost everyone recognises the need to purchase it but more often than not feel it is something that can be put off until tomorrow or purchased at the cheapest price because it is fulfilling a regulatory requirement.
However, if that approach is adopted, owners, financiers and investors will have accepted that they might lose an income earning asset due to a non-trading event, which they will need to fund a replacement. Even if this is not understood, these individuals may only be prepared to advance limited funds because they are uncertain about the ability of the business to repay the amount lent.
I was in charge of insurance arrangements for large companies, which included two FTSE 200 companies in the UK together with The Jumeirah Group, Dubai Holding and ADNEC in the UAE. During this time significant insurance claims were made following a loss of an asset due to an insurable risk and these were paid out in full enabling the businesses to trade normally during what were very difficult times. Therefore for me, insurance has played a critical part in ensuring that capital was made available at a time it was most needed.
Principals of Insurance
The principal behind most reputable insurance policies is to put the policy holder back to the position it was the moment before an insurable event happened. An insurable event is one that typically is not controllable by the beneficiary such as a fire or storm.
The development of the insurance market in London in the 17th Century was one of the principal reasons why the industrial revolution was such a success because it encouraged financiers to fund projects as it removed the fear of losing their investment following the loss of an insured asset such as a ship or factory. Insurance proceeds were therefore seen as a way investors could at least recover their investment at a time when the business was not in a position to repay them.
What do business insurances cover?
Business insurance can generally be divided into two areas. First, insurances relating to the loss of an asset and second insurances relating to a claim from a third party against the business. Whichever area is covered an insurance policy will only meet a claim following the occurrence of an insurable event.
Insurable events occur in certain circumstances. The event must create a definite loss which means that the loss takes place at a known time, known place and from a known cause. In addition, the event causing the loss must normally be outside the control of the beneficiary. The financial effects on the business from the results of such a loss should be large enough to make it difficult to finance using internal resources
Therefore as a sweeping generalisation, asset (or property) insurance is of most use where a business operates out of a property or uses trucks or ships to transport their goods. While liability insurance is used in circumstances where third parties rely on the skills of the business when using their products or services and they are likely to suffer financially if those skills are poorly executed by the provider.
Thinking about insurance as a source of capital
Today, generally insurance is often seen as an unnecessary expense or it is purchased as a compliance requirement. In addition, because most of the experiences with the insurance industry are with the purchase of domestic policies such as car or home insurance arrangement where the cover meets regulatory requirements, price has become the most important aspect.
However, for most trading businesses that have got past the start-up phase, they will have a lot of their revenues dependent on the use of a property and the loss of that asset and the contents due to a fire, which is a fairly common occurrence in the UAE, would be very difficult to replace without having to obtain additional finance.
In these circumstances, it is often difficult to raise this amount of money because monies have already been borrowed against the use of that asset either through a mortgage or for the original purchase of the stock and the lenders will look for repayment prospects before considering making further loans. Therefore, at a time of crises the capital markets can become locked to the business thereby threatening its survival.
Having in place the right insurances will provide a reliable source of capital to the business. Because the timing of an insurable event is uncertain, it would seem sensible that some consideration is given when buying the insurance policy as to whether the company has the necessary capital to make the payment of a claim in a timely fashion. Therefore evaluating an insurance company in the same way as normal sources of finance is a very important action to take.
Other benefits provided by insurance
Insurance is used to finance losses arising out of an insurable risk. Therefore as an industry, insurance companies understand those risks better than individual businesses. Finding the correct broker and insurance partner, helps businesses put in place cost effective controls that can reduce the risk of an insurance event.
For example the fixing of a lightning conductor on a tall building can prevent damage to the building from a lightning strike. For those that do not think it will happen to them, there are numerous pictures of lightening striking the Burj Al Arab.
Furthermore, having a reputable insurance policy in place gives confidence to third party financiers that their investment can be secured in the event of a loss and that the owners are serious about looking after their assets. This helps them in having confidence about ensuring the repayment of the monies, which is the single most important goal of an investment partner.