Page 502 - Business Principles and Management

Chapter 18 • Credit and Insurance

18.3 Insurance Principles

Goals Terms
• Discuss several ways that businesses can attempt • insurance
to reduce risks. • insurance rate
• Define important insurance terms. • actuaries
• Describe several noninsurable risks facing busi- • insurable interest
nesses and how managers can respond to each. • deductible

Insurance and Risk Reduction

If you have $5 in your pocket, there is a risk that you might lose it. Although
you might not want to lose the money, its loss would not be a serious problem.
However, if you own a $300 bicycle, you may not be able to afford to replace it
if it is stolen. You may choose to buy insurance to protect against the larger loss.

WHEN BUSINESSES NEED INSURANCE
If you own a business, you face uncontrollable events that could result in finan-
cial loss. A fire could destroy your building. Someone might steal your property
or money. A customer or employee could get hurt at the business and sue you.
Or an important employee could quit or even die, leaving a gap in the skills
needed to run the business. Some events could be minor (like a broken window)
and so have little effect on the business. However, a major loss could result in
the failure of the business. Consider the problem faced by Sandra Gilbert and
her new jewelry business, discussed in the opening scenario. Because she didn’t
have the proper type of insurance, she lost thousands of dollars of inventory and
had no way of recovering the cost. Many small businesses do not have the re-
sources to survive a loss of that size.
Businesses face risks every day. Managers must determine the types of risk
the business is likely to face and find ways to reduce or eliminate the risk. If
an important risk cannot be eliminated or reduced, the business may purchase
insurance to protect against a loss that would result in its failure. Insurance is
a risk management tool that limits financial loss from uncontrollable events in
exchange for regular payments. As Figure 18-5 (see p. 490) demonstrates, business
losses can be very expensive.

MANAGING TO REDUCE RISK

Just as you would not buy insurance to protect against the loss of a $5 bill,
businesses do not insure against every possible financial loss. As a normal part of
operations, businesses experience losses due to operational problems. Planning can
anticipate those problems and prevent them from harming the business so much
that it cannot continue to operate. Most businesses expect a certain amount of
shoplifting and employee theft. Rather than insuring against that loss, they take

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