Did you think of getting sued when you started a business? No. Nobody does, but things happen.
Many business owners are taken to court for negligence or physical or financial injury. And it’s not always the customers, but also the employees.
Small businesses are especially vulnerable to lawsuits. Data shows that a significant number of small businesses—somewhere between 36% and 53%—face lawsuits every year.
These cases can be incredibly expensive. Each case could cost a business as much as $150,000, particularly if it goes to trial.
The only way to save yourself from financial woes? Covering yourself and your business with adequate insurance.
But insurance policies often include jargon that is difficult to understand. Two concepts—compulsory excess and voluntary excess—are especially important.
Understanding these excesses is important to get the right coverage and manage costs. So, let’s dive in to discuss the two.
First, What is Insurance Excess?
Your excess is what you pay upfront when you make a claim. After that, your insurance covers the remaining costs. If your excess is $300 and your claim is $1,500, your insurer will pay $1,200 while you handle the first $300. It’s that straightforward.
Compulsory and Voluntary: Two Types of Insurance Excess Explained
The two types of insurance excess are as follows:
Compulsory Excess
Compulsory excess is the set amount you pay before covering the rest of a claim. Yahoo! informs that the insurance company decides your excess and you can’t change it.
Your insurer determines the compulsory excess based on several risk factors, such as:
- The type of insurance, such as general liability, workers’ comp, or professional liability
- Your claims history
- The nature of your business operations
- The level of risk involved
Suppose you own a construction company, and one of your employees suffers an injury at work. If your workers’ compensation policy includes a compulsory excess of $1,000, you’ll need to pay that amount before your insurance provider covers the rest of the claim.
The goal of this excess is to make sure that businesses take some responsibility for their claims. According to Prescient National, employers can save a lot on their insurance premiums when they take on some of the risks themselves.
Want to learn more? Getting in touch with an insurance company would be the best bet.
Voluntary Excess
Voluntary excess is an additional amount you choose to pay on top of the compulsory excess. When it increases your out-of-pocket expense, why would you willingly do that? Because it can reduce your insurance premium.
The higher the voluntary excess, the lower your insurance premium. In other words, it’s a trade-off. You’re essentially betting that your business won’t need to make a claim. Some insurers offer attractive discounts if you agree to a higher voluntary excess.
For instance, if your compulsory excess is $600 and you add a voluntary excess of $600, your total excess would be $1,200. Hence, your insurer will reward you with a lower premium because they see you as a lower-risk policyholder.
How to Balance Compulsory and Voluntary Excess? 3 Strategic Considerations
Here are some key factors to consider when setting your voluntary excess:
1. Balancing Risk and Cost
Opting for a higher voluntary excess can lower your insurance premiums. That sure makes it an appealing choice for cost-conscious businesses.
But be careful—not all savings are worth it. If your excess is too high, a sudden claim could strain your finances. Instead, choose an amount that reduces premiums but won’t leave you scrambling for cash when you need to claim.
2. Claim History of Your Business
If your business has rarely made claims, increasing voluntary excess could be a smart move to cut costs.
But the same isn’t advisable if you’re in a high-risk industry where claims are more frequent.
Take the construction industry, for example. Risk & Insurance informs that workers’ comp claims above $2 million rise in cost as well as frequency.
Now, if you opt for a high voluntary excess, you might struggle to cover multiple claims. That will put your cash flow at risk. Instead, you must keep excess manageable to avoid unexpected financial strain.
On the other hand, if you run a low-risk business with few claims, increasing voluntary excess can lower premiums without much downside. It’s all about knowing your risk profile and choosing wisely.
3. Cash Flow and Emergency Funds
Before you set a high voluntary risk, consider whether your business can afford to pay this amount today without stress. If the answer is no, it might be too risky.
Only if you have a healthy emergency fund can you confidently choose a higher excess. That gives you peace of mind, knowing you can cover a claim without disrupting operations. But if cash flow is tight, a lower excess might be the safer bet.
Insurance excess isn’t just a technicality but a strategic financial tool. It can impact your business’s cash flow, risk management, and long-term insurance costs.
The goal isn’t just to get the cheapest policy but to find one that actually works for you in a real-world scenario. Take a few minutes to review your current policies and adjust accordingly. Rest assured that you’ll be in a much stronger financial position next time you need to make a claim.
