“What Liability Limit Should We Carry?”… an incredibly common insurance question with only one really good answer.
True protection and appropriate risk transfer to insurance requires that three important questions be answered…
1. What is the greatest catastrophic liability exposure to our organization or family?
Whether it’s a claim for loss resulting from distracted driving, construction defect, defective product, or a 3am fire in an apartment building (just to name a few), its critical to pinpoint catastrophic loss potential and estimate its financial implications.
2. What is the business equity or personal net worth that must be protected?
This is the organization or individual net worth that must be insulated from lawsuits.
3. What “insurance premium budget” makes financial sense for the business, individual, or family?
One insurance agent explained that he asks his clients, “If liability insurance was free, how much would you want?” He then provides premium pricing for liability limits in $1MM increments to locate an insurance premium budget that the client considers “financially healthy” for his/her organization or family.
A Few Other Considerations
Contract or Legal requirements - Leases, independent contractor/consultant agreements, construction contracts and a ton of other agreements all have liability implications and typically required liability limits. The important thing to note here is that buying insurance to satisfy a liability insurance requirement, without considering these three questions, may result in inadequate protection.
Frequency, Severity and Deductibles - Frequency refers to the number of claims that occur over a given period of time. High frequency means that a large number of claims have occurred or is expected to occur. Severity refers to the cost of a claim, with high severity claims being more expensive than average estimates and low severity claims being less expensive than the average. When frequency is low and severity is high, it can make sense to purchase liability insurance with a large deductible so that more of the premium budget can be spent on purchasing a higher insurance limit.
Likely Settlement Amounts – A common thought is that litigants typically settle within the insurance limit purchased rather than pursuing a recovery beyond the insurance. This situation can occur but has a lot to do with the nature of the liability claim, the amount of the responsible party's equity or net worth, and whether the business or individual/family would be considered a “deep pocket”. Counting on “common thought” as a risk strategy related to lawsuits for negligence can be a bit like playing Russian roulette…probably not the best strategy.
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