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Third party insurance, defined as insurance purchased by an insurer (1st party) to protect the insured (2nd party) against claims made by someone outside this agreement (a 3rd party), is a common way to hedge risk in a business. This insurance can come in 2 forms: liability or as a part of full coverage insurance. Liability covers the damages to only the 3rd party. Full coverage insurance covers the damages for the third party as well as those for the insured.
Third party insurance is a way to mitigate the cost of damages which occur to an unexpected victim. You can purchase it as coverage on a variety of assets. Or you can purchase it for a single asset, most commonly a motor vehicle, or a series of assets such as an entire business. For the vehicle, this insurance protects the purchaser from damages made to an outside party due to some sort of accident. For a business, this insurance protects any of the businesses assets from damages created by any other part of the business. As with any other insurance, it is purchased in specific amounts, bears a deductible for any claims made, and has a term sheet made which defines requirements and limitations.
You can purchase third party insurance coverage for both tangible and intangible assets. For example, a machine in a manufacturing plant can physically damage a plant visitor, but so can a website which posts improper information that defames the name of another entity. Some third party insurance coverage is recommended for any business venture. And it is usually included in business insurance. Insurance, third party included, is a necessary cost.
Leroy is the owner of a small insurance syndicate which provides services to small, local businesses. Leroy, who started at the lowest job in a major insurance firm and worked his way up to becoming a self-made entrepreneur of his own. As a result, he knows a little something about his business. In fact, he reviews the major claims made to his company every day.
His assistant informs Leroy of a claim that just came in. Apparently one of his client companies, a cloth dying plant, has had an accident. This accident has, unfortunately, hurt 2 employees and a visiting client. Leroy knows what to expect with the workers compensation claim made by this business; he has many calculating applications which provide him a range of costs for this claim.
What concerns Leroy, however, is the third party insurance reimbursement he may be facing. The visiting client, known to Leroy as his insurance third party beneficiary, has apparently hired one of the best lawyers in the city. Leroy is not used to this type of claim, due to how unusual they are. Thus, he is concerned. If the court case associated with this claim wins a large settlement, then it could mean trouble for his company. He knows that his company will survive long term, but in the short term this may create issues in the cash cycle of his company.
Leroy does proper research by looking back into the deductible and total coverage associated with the claim which this third party insurance covers. It seems, perhaps, he was a little more worried than he needs to be. The claim only covers a small portion of the potential sum from the lawsuit. Additionally, the company has made small payments and opted for a relatively large deductible should any problems arise. This, to the misfortune of the business owner being sued, prevents Leroy from paying a large sum in settlement. He resolves to do a little more research but can relax for the time being.
Leroy ends his research on a good note. The case is dropped due to an outside factor. Leroy, knowing that his business would have survived either way, resolves to keep higher cash balances for any future problems. This will protect him from any future, unexpected third party insurance claim.