Expert Commentary

Insuring the Home-Based Business (Part 1)

The United States has experienced a rapid growth in home-based businesses in the last decade. The latest studies indicate that there are over 11 million home-based businesses in the country, a figure that is expected to rise in the coming years. A recent survey, however, found that a majority of these businesses do not have the proper insurance coverage. Part 2 of this series discusses court decisions and interpretations of what constitutes a "business." Part 3 of this series, looks at the proper endorsements and policies needed to adequately protect home-based businesses.


Personal Lines Insurance
May 2006

Many businessowners assume that their homeowners insurance policy protects them from any potential losses related to their home-based business. Most homeowners forms, however, provide little protection for a vast number of home-based businesses due to a variety of property and liability exclusions and limitations. When losses do occur to business operations in which no commercial insurance is available, the businessowner often looks to his homeowners policy to provide the necessary protection. In cases where the insurer denies coverage and the case goes to trial, the issue often hinges on the definition of "business" and the particular facts of the business and the loss. In many cases, the courts uphold the business exclusion, leaving the businessowner without coverage.

The solution to this problem is procuring the proper insurance coverage for the home-based business. The necessary insurance can often be obtained through the appropriate homeowners endorsement(s), of which there are several types. For larger home-based businesses, the solution may be a separate businessowners policy (BOP). Insurance agents and brokers who focus on personal lines insurance should become aware of this growing loss exposure and utilize risk management techniques to proactively deal with it. This program should also evaluate other potential insurance gaps and needs for the business, such as automobile, excess liability, professional liability, and workers compensation coverages.

This article focuses on information and statistics concerning home-based businesses and the lack of coverage under standard homeowners policies. Future articles in this series will examine how the courts have interpreted the concept of business, available homeowners endorsements for this exposure as well as the BOP, and the additional insurance products necessary to properly handle this burgeoning loss exposure.

Home-Based Business Statistics

Home-based businesses are a rapidly expanding form of business in the United States. A February 2004 study by the Independent Insurance Agents & Brokers indicates that approximately 1 in 10 U.S. households operate some type of full- or part-time home-based business. These types of businesses make up about 53 percent of the small business population and represent a broad cross-section of U.S. industrial sectors. Approximately 60 percent are in the service industries, 16 percent in construction, 14 percent in retail trade, and the remaining are scattered in transportation, communications, wholesale trade, manufacturing, finance, and other industries, according to the Small Business Administration, "Small Business Research Bulletin: The Small Business Economy 2004."

Home-based businesses tend to be sole proprietorships, employing fewer people and earning less revenue than other businesses. See Table 1 for employment percentages.

Table 1
Home-Based Businesses—Number of Employees

Number of Employees Percentage
No Employees 91.6
1-4 7.2
5-19 1.0
20 or more .2
Source: Small Business Administration, "Home-Based Business and Government Regulation," Washington D.C.: Office of Advocacy, February 2004, p. ES-1.

See Table 2 for revenue percentages.

Table 2
Home-Based Businesses—Revenue Size

Annual Gross Receipts Percentage
Less than $25,000 77
$25,000 to $50,000 19
$100,000 to $500,000 3.5
$500,000 or more Less than 1
Source: Small Business Administration, "Home-Based Business and Government Regulation," Washington D.C.: Office of Advocacy, February 2004, p. ES-1.

Annual Gross Receipts Percentage

These types of businesses are of particular interest due to their potential as a fountain of economic activity. Homes can serve as business incubators, collectively providing start-ups with an entry point into the business world. According to Fortune magazine, Dell Computers, founded in 1984 in a university dorm room, is now the 25th largest company in the United States. The Internet, in particular, has played an important role in the development of home-based businesses. For example, Ebay selling has become a popular type of home-based business. Other popular types of home businesses include massage therapy, business and career coaching, computer consulting, computer repair, elder services, financial advising, and Web-mastering.

This growth, however, has resulted in many coverage gaps for these business owners. A recent study conducted by the Independent Insurance Agents & Brokers of America indicated that 58 percent of home-based businesses are without business insurance. For these uninsured business owners, 87 percent did not understand why separate insurance for the business is necessary. See Table 3 for additional survey responses from uninsured home-based business owners.

Table 3
Uninsured Home-Based Businesses—Survey Responses

Reason for Uninsured Status Percentage
Other insurance unnecessary since they had a homeowners policy 39
Business was too small or posed no risk 29
No reason 19
Total of all home business owners who do not realize need for separate insurance 87
Source: Independent Insurance Agents & Brokers of America, "New National Survey Finds Nearly 60 Percent of Home-Based Business Owners Without Insurance," Press Release: February 25, 2004

The survey indicated further that these businessowners assumed that insurance for fledgling home-based businesses was too expensive. And the March 1, 2004, issue of National Underwriter Property & Casualty-Risk & Benefits Management indicated that 11 percent of businesses without insurance experienced a loss.

Coverage Limitations under Homeowners Policies

The assumption that standard homeowners policies provide coverage for home-based businesses is a dangerous one. This policy contains an assortment of property and liability restrictions for business-related loss exposures. Note that the "business" definition is also an important provision to review when ascertaining coverage.

Business Property Restrictions

The Insurance Services Office, Inc. (ISO), Homeowners 3—Special Form (HO 3), a commonly used form promulgated in 2000, precludes property coverage for "other structures" such as a detached garage or separate nondwelling building, from which any "business" is conducted. Thus, if the insured operates a home-based business out of his detached garage, this structure is not covered.

A related exclusion stipulates that any structure used to store business property solely owned by an insured or a tenant of the dwelling would be covered, provided that the stored items do not include liquid fuel. For example, if Mary stores training materials used in her home business in her storage shed in the backyard, coverage would be provided for the shed. However, if Mary stores fuel supplies for a jet ski rental business in the detached garage, coverage would not be afforded for the shed. An exception preserves coverage for the structure if the fuel is in a permanently installed fuel tank of a vehicle or craft stored in the structure.

The HO 3 also specifies a $2,500 limitation on property located on the residence premises, used primarily for business purposes. Thus, if the insured has a $4,000 computer, used primarily for her home-based graphic art business, which is stolen from her home or damaged in a fire, the loss paid is limited to $2,500.

In addition, the HO 3 contains a $500 limitation on business property located away from the residence premises. Thus, if the insured is taking the same computer to a repair shop and it is stolen out of her car, the loss paid is limited to $500. The American Association of Insurance Services (AAIS) homeowners form contains a $250 limit on business property located away from the insured premises.

Business Liability Restrictions

An even greater loss exposure concerns legal liability for a home-based business since most homeowners policies contain liability exclusions for business-related activities. The ISO HO 3 excludes bodily injury or property damage:

  • arising out of or in connection with a "business" conducted from an "insured location" or engaged in by an "insured", whether or not the "business" is owned or operated by an "insured" or employs an "insured."

The policy, however, does allow an exception for businesses engaged in the:

  • rental of an insured location (a) on an occasional basis if it is used only as a residence, (b) in part for use only as a residence, unless a single family unit is intended to be used by the occupying family to lodge more than two roomers or boarders, or (c) in part, as a office, studio, school, or private garage.

A second exception concerns an insured under age 21 involved in a part-time, self-employed business without any employees. The vast majority of home-based businesses, however, do not fit into these two categories.

Another important liability exclusion pertains to professional services. The HO 3 excludes any type of bodily injury or property damage arising out of the providing of or failure to provide professional services. The courts generally rule that a professional service is one requiring specialized knowledge or mental, rather than manual, skills.

The homeowners policy is intended to cover personal loss exposures, not professional exposures. For example, if John is an attorney who works out of his home, he needs to procure a separate professional liability or errors and omissions (E&O) liability policy to protect him from lawsuits stemming from his professional acts.

"Business" Definition

The next issue pertains to the definition of a "business." The ISO HO 3 defines a "business" as a trade, profession, or occupation engaged in, regardless if it is on a full-time, part-time, or occasional basis. Any other activities in which an insured participates for money or other compensation qualifies as a "business" with certain exceptions. (Note: Many insurer homeowners forms do not contain any exceptions to the business definition.) Four minor business-related type exposures are specified as non-business activities and are thus covered under the HO 3.

The first exception concerns activities that are not described in the next three exceptions, for which an insured receives $2,000 or less in total compensation during the 12 months preceding the effective date of the policy. For example, John works at a regular daytime job; however, he has a substantial baseball card collection, and he occasionally advertises to sell specific cards on the Internet. His revenue from this avocation in the preceding 12 months was $1,300. If a baseball card customer coming to John's house slips on the sidewalk and is injured, coverage for this loss arising from this sideline avocation is not affected by the form's business exclusions and limitations.

The second exception involves volunteer activities in which no compensation is provided other than expenses paid to perform the activity. Suppose that Frank volunteers at a local hospital. He is paid only for his gasoline expenses to and from the hospital. Assume further that he helps an elderly patient sit in a chair and the patient falls and subsequently sues Frank for negligence. The homeowners form does not categorize this situation as a "business" activity; thus, the form's business exclusion would not apply.

The third exception concerns home day care services. Occasional day care services provided for which no compensation is involved, other than the mutual exchange of such services, is not considered a "business" exposure. For instance, assume Mary has a 3-year-old child and her neighbor has a 4-year-old child. If these two women take turns babysitting each other's children with no exchange of money, this activity does not fall into the business category.

The fourth exception pertains to the rendering of home day care services to a relative of an insured. For example, Mary is a retired individual who cares for her mother in Mary's home. This is not considered a "business" activity, regardless of whether any payment is involved.

This definition is fairly broad-based; however, the concept of business is not always precise and clear-cut. For example, a hobby can eventually turn into a profitable and growing business. Conversely, a sideline business that is not profitable and is operated on an erratic basis may not be viewed as a business per se by the courts.


Part 2 of this series discusses court decisions and interpretations of what constitutes a "business." Part 3 of this series looks at the proper endorsements and policies needed to adequately protect home-based businesses.


References:

American Association of Insurance Services, "Home-Based Businesses," Viewpoint, Winter 2005, 29:3. Available at www.aaisonline.com [accessed April 17, 2006].

Fortune, "Fortune 500," 2006, Available at http://money.cnn.com [accessed April 17, 2006].

Independent Insurance Agents & Brokers of America, "New National Survey Finds Nearly 60 Percent of Home-Based Business Owners Without Insurance," Press Release: February 25, 2004. Available at http://www.iiaa.org [accessed April 16, 2006].

Insurance Information Institute, "I.I.I. Offers Insurance Checklist to Owners of Home-Based Businesses," March 16, 2004. Available at www.boj.com [accessed April 17, 2006].

Olson, Robin K. Personal Risk Management and Insurance, Dallas, TX: International Risk Management Institute, Inc., 2006.

Ruquet, Mark, "Home-Businesses go Bare." National Underwriter Property & Casualty—Risk & Benefits Management, (March 1, 2004) 108:8, p. 11.

Small Business Administration, "Small Business Research Bulletin: The Small Business Economy 2004," Washington D.C.: Office of Advocacy, 2004, p. 1.

Wahm Connection, "Top 10 Home-Based Business Opportunities," 2005. Available at www.thewahmconnection.com [accessed April 16, 2006].

Xeal Precision Marketing, "Ebay Selling Becomes a Popular Home-Based Business," August, 2005. Available at http://www.xeal.com/ [accessed April 15, 2006].


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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