THE IMPACT OF LIABILITY INSURANCE ON SMALL BUSINESS
Kenneth A. Heischmidt, Southeast Missouri State University ABSTRACT Increases in liability insurance costs has affected all business in the United States. Small business has been especially impacted. This study investigated the impact of liability insurance costs on small business. A telephone interview survey was used to contact 165 small businesses in Cape Girardeau, Missouri. The results of the survey indicates that about 75% of the small businesses have experienced an increase in insurance premiums in the last 24 months. The businesses dealt with these increases by decreasing their insurance coverage 57% of the time and by passing the increased costs on to customers 21% of the time. INTRODUCTION While the insurance situation affects all businesses, the small business operator is especially prone to feel the effects of rising insurance premiums. This study was completed to better understand the impact of liability insurance on small business. The sample in this study consisted of small businesses in Cape Girardeau, the commercial hub for southeast Missouri. Three research questions were investigated: 1. What percent of small businesses have experienced premium rate changes in liability insurance in the last two years? 2. Of small businesses experiencing increased liability premiums, in what ways have the businesses dealt with these changes? 3. Do owners of small businesses feel there is a liability problem among small businesses at the present time? Appropriate demographic characteristics of the respondents are included. In total 165 small businesses were contacted in the phone survey. RELATED INFORMATION The coverage provided by liability insurance is essential to many small businesses. However, there is a rising concern over the increasing costs of maintaining adequate liability coverage in the last ten years. These increased costs may be directly related to the increases in liability suits. Between 1977 and 1982, the number of civil law suits in state courts grew four times faster than the population in the United States. In the period between 1974 and 1984 the number of product- liability suits in federal courts increased 680% (5). The average verdit today in product liability suits is over one million dollars (9). The present insurance situation is affecting businesses in different ways. Many larger businesses can absorb the rising costs of insurance. Smaller firms cannot absorb these costs as easily and have responded by decreasing or eliminating their product liability coverage in many instances. A fundamental reason for this present situation with liability insurance is the stated losses insurers have taken due to increased liability awards (7). The insurers attribute the problem to lawyers fees and court awards. Lawyers attribute the situation to big business negligence. Big business is observing a change in the general publics willingness to bring suits. The result of all this finger pointing is unmanageable costs that small business must pay to receive insurance coverage. Not only are small businesses having difficulty in covering the costs, sometimes their liability insurance coverage is even cancelled (3). There appears to be a concentration of large law suits in certain areas of the United States. New York, California, and Florida are the top three states that have awarded multi-million dollar settlements (4). Certain states are acting to limit certain liability awards. In Missouri there is a 350,000 dollar cap for non-economic loss in liability cases, yet wages and medical expenses are not capped (10). Many small businesses are being affected by the present insurance situation. A representation of these effects will be provided. Most U.S. ski lift equipment manufacturers had their insurance cancelled or significantly increased due to the accident at Colorado's Keystone Resort in 1985 (5). In response to this accident there was a significant increase in the price of daily lift tickets.
Small trucking, bus lines, and city subway systems are all affected by the increasing costs of liability insurance. The American Public Transit Association reports premium increases of 300% to 1,200% in the last couple of years for bus and subway operators (12). The Southern California Rapid Transit District nearly shut down when its annual premium rose from $67,000 to $3.2 million (3). The American Trucking Association reports more than 100 companies have collapsed and more are expected to fail due to increased insurance costs. Insurance companies are raising premiums for bars, restaurants, and liquor retailers. A restaurant in Concord, New Hampshire, protested a premium hike from $1,000 to $12,000 per year by sponsoring an Unhappy Hour of dramatically increased drink prices (3). Bismark Food Services, which sells beer at Detroit Tiger Stadium, had a premium of $50,000 in 1983 which increased to $1 million in 1986 (3). Nationwide day care centers are facing a significant liability insurance problem. Because of widely reported cases of child abuse and molestation, the cost of insurance for day cares has risen significantly from 1980 to 1984. The average cost of insurance has risen from $7 to $70 per child. Additionally, liability insurance has been cancelled for more than 17% of child care centers nationwide (7). Some groups significantly affected by the insurance crises are in the medical professions. Insurance premiums for oral surgeons in Detroit has risen about 200 percent in the last two years. A typical neurosurgeon on Long Island had premium increases in 1985 of $66,000 to $100,000 (12). The hardest hit group of the medical professions may be in the field of obstetrics. Coverage for obstetricians now runs up to $72,000 per year resulting in many refusing to deliver babies (3). To conclude, no business has escaped the rising costs of today's insurance coverage. Some businesses have experienced over 500% increases in premiums in recent years. This insurance situation has caused many small businesses to decrease liability coverage, lower their profits, or discontinue operation of their business. METHODOLOGY A telephone interview survey was used to contact 165 small businesses in the Cape Girardeau area of southeast Missouri. These small businesses were chosen from over 1,000 businesses registered with the Finance Department in Cape Girardeau. A systematic random sampling procedure was utilized to identify the sample group. The attitude survey included both demographic and liability insurance content questions. In order to assess the content validity of the survey it was screened by 16 semi-professionals and pretested with two local businesses, one retailer and one service provider. Their suggestions were used in the final revisions of the survey. Descriptive statistics including percentages were used to describe the demographic characteristics. The chi-square test of independence was utilized to measure the relationship among the categorical independent variables (i.e., location, business focus, years in business, after-tax profits) and dependent variable which was their feeling of the existence of liability problems for small business today. RESULTS The demographics of the survey reported in Table 1 indicate that 41% of the respondents have been in business three years or less, while 57% have been in business 13 years or more. An approximate equal number of service and retail goods businesses were represented. Ninety-three percent of the businesses do carry some liability insurance while 74% of the businesses have experienced a change in insurance premiums in the last 24 months. Approximately 96% of insurance premium changes resulted in increases in insurance costs. About 57% of the businesses experiencing an increase dealt with it by decreasing their insurance coverage while 21% passed the costs on to customers. Only 15% of the businesses have experienced a liability claim against them in the last five years. A majority, 66%, felt that there is a problem with liability insurance costs with their business industry. The chi-square test of significance was used to measure the association among categorical independent and dependent variables. The results of the chi-square tests are provided in Table 1. Three variables provide results of interest for the
reader. Change in insurance cost in the last 24 months indicated a significant relationship with the dependent variable at the .0004 level. Additionally, the occurrence of a liability claim against the respondents business in the last five years also produced results at the .04 significance level. The variable, type of change, provided a chi-square significance of .07 which should be additionally considered. TABLE 1 CHI-SQUARE TEST OF ASSOCIATION AMONG CATEGORICAL INDEPENDENT VARIABLES AND THE DEPENDENT VARIABLE (FEELINGS OF LIABILITY PROBLEMS WITH THEIR BUSINESS INDUSTRY) Variable Alternative Percentage (%) Years in Business in Cape (n) (%) 0 - 3 41 27 x(2) = 3.90 4 - 6 24 15 df = 4 7 - 9 16 10 Significance = .42 10 - 12 14 8 13 Plus 57 40 Business Focus - Services (n) (%) Financial 14 18 x(2) = 2.38 Professional 3 3 df = 4 Home, Auto 21 25 Significance = .67 Beauty, Personal 12 15 Other 30 39 Business Focus - Goods (n) (%) Home, Office, Gift 16 19 x(2) = 2.47 Auto 16 19 df = 4 Food, Drug 13 16 Significance = .65 Clothing, Sporting 10 13 Other 29 33 Does Business Carry Liability Insurance (n) (%) Yes 140 93 x(2) = 1.39 No 11 7 df = 1 Significance = .40 Change in Insurance Cost in Last 24 Months (n) (%) Yes 108 74 x(2) = 12.39 No 39 26 df = 1 Significance = .0004 Type of Change (n) (%) Increase 105 96 x(2) = 3.17 Decrease 4 4 df = 1 Significance = .07 How Was Increased Insurance Cost Dealt With (n) (%) Passed Cost to Customers 21 20 x(2) = 2.07 Decreased Liability Coverage 57 53 df = 4 Changed Insurance Company 13 12 Significance = .72 Self Insured 6 6 Other 10 9 Has There Been a Liability Claim Against Your Business in the Last Five Years (n) (%) Yes 23 15 x(2) = 4.27 No 127 85 df = 1 Significance = .04 Do You Feel There is a Problem With Liability Insurance Costs With Your Business Industry (n) (%) Yes 100 66 No 52 34 What Is Your Approximate After-Tax Profit (n) (%) 0 - 25,000 32 30 x(2) = 1.32 25,001 - 50,000 39 35 df = 2 Over 50,000 40 36 Significance = .52 DISCUSSION Based on the empirical data presented, certain conclusions can be drawn with respect to the attitudes of small business operators in Cape Girardeau, Missouri toward business liability concerns. The data suggests that the certain demographics of Cape Girardeau small businesses, i.e., years in business, business focus-services, business focusgoods, businesses carrying liability insurance, and how increased insurance costs were dealt with, were not significantly related to small business operators feelings about the existence of a problem with liability insurance costs within their business industry. The independent variables that contributed the most to feelings of a problem with liability costs within certain industries were as follows: those businesses that had changes in their insurance costs in the last 24 months, those which experienced increases in insurance costs, and those businesses having a liability claim against them in the last five years. While the feelings by small businesses of problems with liability insurance appears to be most closely related to increasing liability insurance costs or liability claims, which appears logical, how these small businesses are dealing with increased liability insurance costs should be more closely reviewed. Over one-half (57%) of the small businesses dealt with these increased costs by decreasing liability coverage. An additional six percent decided to self-insure which may be interpreted as dropping liability insurance coverage. Only 21 percent of the businesses contacted in the study indicated they passed the increased costs on to their customers. The fact that over one-half of the small businesses
sampled decreased or eliminated liability insurance coverage creates a concern related to the perceived lack of legal protection for many small businesses if liability claims were filed against them. The results of this study should be evaluated in relationship to its limitations. The major limitation to be considered is the generalizability of these results beyond the sampled population. Even given this limitation the results may be very beneficial to the small business community. Additional studies that looked at responses from small businesses that are demographically representative of the overall national population may be useful to small businesses in their decisions regarding liability insurance. The comparison of the differences between different types of business, i.e., goods and services, may also be very beneficial. REFERENCES (1) Andresky, J. (1985), Forbes, A World Without Insurance, July 15, pp. 40-43. (2) Bacas, H. (1986), Nation's Business, Liability: Trying Times, February, pp. 22-27. (3) Church, G. (1986), Time, Sorry Your Policy is Cancelled, March 24, pp. 16-26. (4) Cohn, G. (1986), Wall Street Journal, Recent Awards in Florida Reflect Scope of Nation's Liability Woes, April 21, p. 21. (5) Farrell, C. (1986), Business Week, The Insurance Crisis: Now Everyone Is In a Risky Business, March 10, pp. 8892. (6) Forbes, D. (1986), Dun's Business Month, Big Change in Business Insurance, January, pp. 72, 77. (7) Hertzberg, D. (1986), Wall Street Journal, Insurers Beginning to Refuse Coverage on Directors, Officers in Takeover Cases, January 20, p. 3. (8) Hilder, D. and Wynter, L. (1986), Wall Street Journal, Business Struggling to Adapt as Insurance Crisis Spreads, January 21, p. 37. (9) Johnson, J. (1986), Finance, Product Liability Insurance, May, pp. 55-57. (10) Moskowitz, D. (1986), Business Week, Liability: Trying Times, February, pp. 22-27. (11) Weicher, L.P. (1986), Journal of Accounting, The Liability Insurance Crisis: Its Impact on Small Business, May, p. 67. (12) Work, C. (1985), U.S. News and World Report, As Liability-Insurance Squeeze Hits Everyone, October 7, pp. 5657