Welcome to week three of our look at the varying types of insurance you may want to purchase. This week, we leave behind the vast and murky pond of disability insurance and wade into the deeper and even murkier waters that characterize business liability coverage.

What it is
Business owners make mistakes. So, too, do their employees. Business liability insurance provides coverage when those mistakes lead to a lawsuit. An electrical contractor, for example, would file a claim if it were found that his faulty wiring led to a fire that brought about a lawsuit by the homeowner who lost his house in the blaze.

But that's just one type of liability insurance. There are four general categories of business protection you can purchase, according to the Web-based resource AllBusiness.com:

  • General liability coverage: A general policy typically protects a business against claims resulting from bodily injuries that occur on its premises or that result from negligence. Property damage incurred during the course of doing business is usually also covered, as in the example above.
  • Professional liability coverage: Service workers also may need protection in the event of a lawsuit over errors in their work. Medical malpractice insurance is a common form of professional liability coverage.
  • Product liability insurance: TASER (NASDAQ:TASR) employs this sort of insurance to defend against suits that claim its stun guns are defective.
  • Employment practices liability insurance: A relatively new form of protection, "EPLI" policies protect employers in the event of a claim of wrongful termination or sexual harassment.

Should you buy?
But your business won't be sued, will it? Don't be so sure. A quick Google search using the terms "businesses sued" generated 532 results. Consider these two cases:

  • A Sacramento, Calif., attorney has filed more than 100 claims against local businesses he believed violated the Americans with Disabilities Act.
  • Monsanto (NYSE:MON) has sued more than 100 farmers across the country for what it claims are violations of patents related to its genetically engineered seeds.

What's more, legal challenges had become so prevalent in California that ballot Proposition 64, which sought to keep attorneys from frivolously filing claims against ambiguous "unfair business practices," passed with roughly 59% of the vote during the 2004 election. Perhaps lawsuits are par for the course when it comes to owning a business?

Three Foolish questions to ask before you buy
Maybe. Whatever the root cause, lawsuits seem to be rising. That's hardly news to the participants at our Self-Employed Fools discussion board. The overwhelming majority of respondents to a poll I posted last week -- 82% -- say that they either already have liability insurance or plan to get a policy. If that's you, too, allow me to suggest three Foolish questions to ask before you buy:

1. What could a suit cost you? Sole proprietorships and other non-corporate structures mix personal and business assets under a single roof. So, if your business gets sued, it's your assets that will be on the line. Structuring your firm as a corporation or limited liability company (LLC) offers slightly more protection by distinguishing between business and personal assets. But that won't absolve you from all liability, especially if you -- the owner -- are the one that does the harm. Consider hiring a liability insurance specialist before buying a policy; that person should have a good understanding of common settlements in your industry, which About.com expert Darrell Zahorsky says is critical for determining the amount of coverage you'll need.

2. What do your clients require? At least one respondent to my online polling says that liability insurance was a requirement for doing business. I've heard this many times as well. For example, a writer friend here in Colorado had to purchase professional liability coverage before earning a lucrative contract with a California-based software firm. If you face the same, and if asking for help won't lose you the business, find out which agents and/or insurers your prospective client prefers. That relationship may earn you a needed discount.

3. Are you a member of an association? I'm typically loath to refer to associations when it comes to insurance, because most offer lousy health and dental policies. Not so with liability insurance. Dozens of organizations offer cheap liability policies thanks to the size of their memberships. I was witness to this in my former profession as a PR consultant, in which I had access to Errors and Omissions insurance -- a form of professional liability coverage -- through the Public Relations Society of America (PRSA).

Follow the money
Frankly, as a writer, I may do better with a good lawyer and a well-stocked emergency fund than I would with liability coverage. You may feel similarly. But the harsh truth is that neither you nor I can know what's best for us until we count up our assets, consult a specialist, and plan for the worst. It's at least worth considering.

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Fool contributor Tim Beyers says to stay tuned for next week's coverage of life insurance. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. Get a peek at everything he's invested in by checking Tim's Fool profile. TASER is a Motley Fool Rule Breakers selection. The Motley Fool's disclosure policy is in it for the long term.