keeping business going WHEN DISASTER STRIKES

I first drafted this article a couple of months ago at the request of the editor of Franchise New Zealand, who suggested that franchisors and franchisees might appreciate some advice about insurance cover in the aftermath of the first Canterbury earthquake. Since then, of course, New Zealand has suffered the tragedy of the February 22 quake, there has been the flooding in Queensland and, as I write, news is still coming in of the destruction in Japan. My sincere condolences go to those affected by all three major disasters and especially to those whose losses go far beyond mere money.

One thing that is becoming apparent from all these events is that the ability of businesses to survive, to trade, to move if required and to go on providing employment is a significant factor in the overall recovery of a community. While governments and aid agencies may provide all sorts of assistance in the event of large-scale disaster, however, for business owners there is no substitute for proper risk management and insurance coverage. Apart from major catastrophes, fire, floods, burglaries and other disasters can happen to individual businesses at any time. Overseas statistics suggest that seven out of ten small firms would go out of business if they experienced a major emergency, so franchisees and franchisors need to ensure that they have adequate protection against interruption of their business. Unfortunately, under-insurance is all too common.

I recently (before February 22) arranged insurance for a customer who is based in Christchurch who told me about his experience in the earthquake that hit Newcastle, Australia, in 1974. Thanks to the quake, he lost his business and was made a bankrupt despite the fact that he had Business Interruption insurance. This was because every day he opened his doors he was losing money. Why? Well, what many buyers of insurance do not realise is that any Business Interruption policy should not only take account of the loss of profits that might result from an event but should also be structured to cover:

• Loss of personal income
• Paying staff wages
• Contractual responsibilities of supply
• Maintaining and paying for overheads

Furthermore, this client’s Business Interruption insurance only had a 12-month indemnity period, at the end of which time the insurance company refused to renew his policy. It was not long enough or comprehensive enough to cover all the above factors given the loss of business while he was closed, the length of time it took to get a new Building Permit and the time it took for his market to recover. Eventually, he had to walk away, losing $2.6 million in the process. With hindsight, he believes that he should have had at least six years of indemnity period to enable his business to recover.

Sadly, there will be many similar stories that come out of Christchurch over the coming months. There is no point in blaming the insurance companies: you get the cover that you pay for. It is for this reason that franchisors need to have a real understanding of what types of insurance cover their franchisees should have and how best it can be obtained.

What Cover Do You Need?

In fact, many franchisors have clauses in the franchise agreement stipulating certain types of insurance cover that the franchisee must have – for example, public liability insurance. However, in reality there can still be gaping holes in the planning: the actual level of cover required is often not stated, and franchisors rarely audit to find out whether or not appropriate policies are actually taken out (or renewed) by their franchisees. Some franchisees may skip the requirements to save money or some brokers may arrange a policy that doesn’t actually cover all the eventualities intended. Many standard packages are not properly targetted for a franchise’s specific needs.

The result can be that the franchisee is not only in breach of their franchise agreement (which may be grounds for termination) but also terribly exposed in the event of business interruption. That exposure spreads to the franchisor if franchisees are unable to pay their royalties, particularly when several franchisees are hit at once as in the case of an earthquake.

The types of insurances most frequently included in the franchise agreement are:

• Material Damage  
• Business Interruption
• Public Liability
• Statutory Liability
• Professional Indemnity
• Commercial Motor Vehicle  
• Loss of income due to accident and sickness

In addition to these, other policies that might be considered are:

• Directors and Officers Liability
• Employers Liability
• Trade Credit Insurance
• Death cover and Trauma Insurance
• IT Liability
• Marine Transit Insurance

The need for some of these policies will be dependent upon the type of business that franchisees are engaged in, but the above demonstrates the depth of cover that can be obtained.

Another issue that both franchisors and franchisees need to be aware of is that in certain cases there may be requirements related to particular sites or locations that are additional to anything stated in the franchise agreement. We have recently had discussions with a franchisee who was totally unaware of some specific liability issues related to their business at Auckland International Airport. Without the appropriate insurances, they would be very exposed.

Business Interruption Insurance

The purpose of Business Interruption insurance is to cover the loss of profit due to a reduction in turnover that a business suffers after a disaster. A property insurance policy only covers physical damage whereas a Business Interruption policy may (depending on the policy) cover items such as:

• Gross profit including wages
• Fixed costs (operating expenses and other costs still being incurred)
• Extra costs incurred – thereby reducing the impact of a loss of turnover

A Business Interruption policy is not like car insurance. It is very technical; the policy wordings have to be fully understood and not all insurance companies have the same definitions. It can be very flexible, with many extensions available to fulfil various needs. However, each of these extensions costs more money and some insurers are more flexible than others. The phrase ‘you get what you pay for’ is very relevant in this situation, but in order to get the best value for your money you have to work out what level of cover you actually need and which provider is best able to meet your requirements. This is where you need to sit down with a broker.

Insurance is another area where franchises should offer an advantage over independent small businesses. Given that most franchisees within a business will have the same needs and risks, it is possible for franchisors to work with a broker to develop a basic insurance package that will provide an appropriate level of cover for their franchisees. In order to do this, the broker will need to understand the nature of the business, its market, the specific requirements of the franchise agreement and any other contractual obligations (eg. to suppliers and landlords) that franchisees share. This may take some time and will require honest and open discussion of the issues. It may also require sampling – if not a full audit – of franchisees’ current insurances.

Armed with this information, the broker is then able to approach insurance providers and to put together a package that is tailored to the needs of the specific franchise. This can provide the requisite levels of cover to protect the business while not paying for more than necessary. Bulk buying – a traditional advantage of franchise groups – can further reduce costs and any individual requirements (like those of the airport site) can be added as extensions to the basic package.

Risk Management

Having the right insurances in place is only part of the answer to disaster-proofing your business; another important factor is risk management. Risk management is the process of eliminating dangers to the business in advance through careful assessment, management and good practice. For example, if a franchisor provides standard terms for their franchisees to give to their customers, such documents can be invaluable when securing payment for customers affected by fire, earthquake or some other peril. If a franchise’s operating systems and database and securely backed-up off site or managed via a cloud computing network, disruption in one location will not affect all the others. Many risks can be reduced or eliminated through foresight – it is the risks that can’t be eliminated that you must insure.

For many businesses the thought of sitting down and working out a risk management plan is just not appealing. Some 12 years ago I put together a team to talk to companies about their financial risk management plans on the subject of ‘What happens if?’ But the only companies interested were those who had already experienced disaster and wanted us to tell them how to get out of the hole they were in.  Risk management is about doing the work before the event, rather than withstanding the cost afterwards, and it’s something every established franchisor needs to consider. There are companies that specialise in this field of work who are risk analysts, often with international experience. 

Disasters need not be accidental, either. A major name in the food industry called in a specialist to establish a disaster recovery plan at one of their Auckland plants. Within his first half hour on site, the specialist found a door to the processing plant which was unlocked. He walked into the factory and was not challenged. What would have happened if someone had entered the building and poisoned some of the filled bottles then held the company to ransom? Yes, they had a Business Interruption policy, but the company had not extended the policy to cover such an act. The financial cost to the business would have been huge. In this case, they were able to identify a risk and reduce it through better work practices. As a result, it was then possible – and more affordable – to insure against it. Any food franchise needs to be aware of the dangers of product contamination and plan accordingly.

Once again, the nature of a franchise means that many risks will be common to all franchisees. This is yet another area where franchisees sharing information and experiences can be used to benefit everyone else within the group.

 Choose Your Partners

There is one other element of risk management that should also be considered, and that is which company you choose to provide cover for your franchise. Many of the insurers in New Zealand who will have received huge claims from Christchurch are the same ones that have been hit for the Queensland floods, and some will have connections with Japan, too.

As a result, there has never been a time in our insurance industry history when the security rating of the insurance companies has been of such importance. Anything rated below the A-grade range by Standard and Poors should be questioned and looked into carefully. It is this rating that will tell you if the insurance company is going to be in the position to pay your initial claim and, in the event of Business Interruption insurance, continue to pay over the extended period covered by the policy.

Businesses will always be affected by disasters of one sort or another, although it is to be hoped that we will not see another on the scale of the Christchurch earthquakes for many years. Having the correct insurances in place and a proper risk management plan can help to mitigate the impact of such events. By working together with their insurance advisor, franchises can help reduce the risk and secure the livelihoods of all franchisors and franchisees alike.

Quick Tips – Are you covered?

1. What insurance cover is necessary, what is desirable and what is realistic in your franchise?

2. What is required under the franchise agreement? Is this cover in place?

3. Are the amounts insured adequate in the event of short and longer-term disruption?

4. Share thoughts, ideas and concerns throughout the system.

5. Introduce a risk management/disaster recovery plan.

6. Act collectively to get the best deal on a package of policies that is tailored to the individual franchise.

This article first appeared in Franchise New Zealand magazine Volume 20 Issue 1 March 2011