Sometimes things don’t go quite as planned and your company ends up a bit more cash strapped than anticipated at year end. The typical gut reaction is to pull the rip chord and cut any and all “extraneous” expenses. Insurance is considered by some to be one of those expenses. Here’s why you shouldn’t be quick to jump to that conclusion.
This is obvious so we won’t spend much time on it. If you let your insurance lapse, all the risk exposure you had prior to purchasing insurance comes back. Depending on the coverage you have in place, this could mean lawsuits for accidents/injuries in the office, product downtime, data breach incidents, and more.
Again, this one is pretty straightforward: you are required by law to carry certain types of insurance. If you have employees on payroll, workers comp, disability, and unemployment insurance are required in most states.
3. Retroactive dates
Most Directors and Officers, Errors and Omissions, Cyber Liability, and Employment Practices liability policies (to name a few) are what’s called a “claims made” policy. With a claims made policy, coverage will commence and date back to the inception of the policy when it is originally bound. The start date at inception on year 1 is called the “retroactive date.” This means that as the years go on, you effectively have a longer period of coverage as the retroactive date sinks further into the past. A recoverable claim in year 4 can arise from a wrongful act that occurred all the way back in year 1 so long as coverage has been continuous and the retroactive date is intact.
If you choose to let your coverage lapse or non-renew, you’re effectively resetting the retroactive date and throwing away your long-tail insurance coverage. Given that startups are more inclined to make mistakes in their early days, it’s not wise to throw away the year(s) already on the books.
More on claims-made policies here.
4. Reinstatement fees & paperwork
It’s not uncommon for an insurance carrier to charge some sort of reinstatement fee when trying to reinstate a policy that has lapsed for quite some time. There will usually be a bit of a grace period for a small lapse, but at a minimum there will some extra paperwork to verify that no claims arose during the lapse period. Startups should be focused on building the business, not extra fees and paperwork.
5. Ruining future prospects
When applying for insurance, almost every underwriter will ask about prior insurance and if your prior policy(ies) ever lapsed, cancelled, or non-renewed (and why). You’ll have to disclose the fact that policies have lapsed and this tends to have a chilling effect on your prospects for getting new coverage in place. Just like a loanee with bad credit, new coverage will likely be more expensive to compensate for the higher risk of a potentially delinquent account.
Startups should think hard before letting their business insurance lapse. It’s an expense that, if cut, could lead to a short-sided win and long-term loss for your company.