Franchisors Supersize Cost Savings with Captives

This article originally was published on Captive.com and is reprinted here with permission.

Today’s franchise operators are struggling for survival like never before. Beyond a competitive landscape with a constant stream of new players, pressure to add trendy menu items, gaps in the supply chain, and the tightest labor market in decades, franchises are beyond eager for help.

Consider how your favorite franchise location looks in an insurance carrier’s eyes. High turnover, low-skill employees dealing with fryers, greater risk for slips and falls, and food safety rules. Lobbies with kiosks for ordering and self-service beverage centers where spills are commonplace. Walk-up customers trying to get past their impatient drive-up counterparts. Little wonder franchisees have seen double and sometimes triple-digit premium increases driven by general liability, property insurance and umbrella coverages – if they can get someone to write it for them - as carriers walk away from the restaurant sector.

The challenges franchisees face when trying to obtain liability insurance reflect the value of nuclear verdicts in U.S. courtrooms and the tactics being used to pressure franchisees by dragging court cases out.

Establishing a captive insurance program is a remarkably effective way for franchisors to ensure their franchisees have access to high-quality insurance coverage that’s better and more affordable than what is available in the current market. The captive approach can also create significant financial incentives for adopting ideas such as worker safety programs that reduce claims, along with the potential to gain tax efficiencies, let alone access to stable coverage.

Many franchisors help their franchisees increase profitability by offering group purchasing programs. Developing a captive insurance program is very similar. It assembles a large group of owners, creates actuarily sound funding levels based on their specific business risks (not some industry average), and provides focused support to drive reductions in the frequency and severity of claims.

One of the keys to a successful captive program is the sheer scale of what’s being insured. The more top-performing franchisees who participate, the better the data and the more control the franchisor is able to exert over claim reduction efforts. The captive will typically need to have at least $3 million in total premium volume to interest most fronting carriers and reinsurers.

The growing flow of private equity money into the franchise industry creates an issue that franchisors and their franchisees are wise to resolve at the beginning of the captive conversation. Typically, when a private equity group takes control of a franchisor, they’re not focused on long-term performance. Instead, their goal is to maximize the returns for five to seven years and then sell the company to another company or group of investors. When that happens, does the captive belong to the franchisees? The franchisees might assume that’s the case, given their role in providing capital to fund the captive, but unless that’s clearly defined in the documents, the franchisees might find themselves essentially being insured by a previous owner who no longer has a stake in their success.

The franchisor also has to begin with the end in mind. Is the goal to make the captive a member-owned effort, or is their primary interest creating a new stream of revenue from franchisees? What are the tax-related goals, and who should benefit? Multiple decisions like these will determine how the captive will be structured and operated.

That makes franchisee education a critical element in exploring and pursuing the captive strategy. Business owners who are normally focused on short-term performance and expenses have to be guided to take a longer-term view. Most franchise systems have some sort of franchisee advisory council that acts as a representative for addressing the concerns of franchisees and relaying information they need to know about business decisions. Educating the council’s members is a good starting point for addressing the idea of a captive insurer. Involving them early may not only head off potential resistance from the larger group of operators, but they’ll be able to contribute to the design of the captive plan.

The key message they can deliver is that the shift to a captive will offer both short- and long-term advantages. In the near term, franchise operators won’t have to scramble to find coverage, they can expect to gain cost efficiencies and pricing consistency; and the coverage will be more closely aligned with the realities of their business. In the long run, the captive’s use of funds to support claim reduction activities will help them realize significant reductions to their overall insurance spend. In addition, captives that are efficiently funded and managed create a nest egg. The franchisee’s share can be used to improve their balance sheet through the dividends received, increasing the value of their business when they’re ready to exit.

While the captive strategy provides a lengthy list of advantages, it also involves many complexities, such as determining the proper domicile and complying with regulators. That’s why a franchisor considering bringing the strategy to its business should work with a captive partner that has experience at helping other franchisors take full advantage of the benefits.