Who's watching the Store? - The Insurance Audit

Protecting the family owned business for the next generation is something that keeps many business owners up at night. How does one best protect his or her critical assets that they have spent years building?

Many rely heavily on insurance as a critical part of the protection strategy against threats to the family business.

What many do not fully appreciate however, is that insurance is merely a promise. It is a "promise" that is defined by the fine print of a company's insurance contracts. This is the reality that can make insurance so frustrating and difficult at times. Buyers should be aware of the potential for significant uncovered losses due to poorly structured coverage. And poorly structured coverage is much more common than you think.

My experience from conducting insurance audits on target acquisitions for private equity firms along with local company audits has shown that roughly 20% had no issues of any consequence and 40% had areas of weakness that could create minor problems if a claim were to arise. However, 30% had errors that were significant and could have resulted in denied claims or underinsured claims that could cost a business tens to hundreds of thousands dollars, and the remaining 10% had issues that had the potential for $1M + uninsured claims.

Why does this happen? The reasons usually fall into 3 general categories:

Company Growth: Exposures grow and evolve quickly making it difficult for the internal buyer and the broker to stay on top of it all. In many cases, the increasing complexity of the risks exceeded the capabilities of those charged with managing them.

Broker Issues: Too little time spent assisting the client with exposure analysis, poor attention to detail, limited access to alternative insurance carriers, or lack of expertise. In many cases, especially when companies are smaller, the relationship with the insurance broker is more of a sales relationship. The broker's focus is on selling an insurance policy and not necessarily on helping the client manage exposure and risk.

Internal Issues: Poor internal communication regarding risk management and the true exposures facing the firm, assumption that most insurance policies provide the same coverage and consequently a narrow focus on price. Price is the attribute that is most easily identified in an insurance program. What the insurance actually covers (the "promise") can be a complete mystery to the buyer. In a way, this is like paying $40,000 for a car and not knowing if you are getting a 2008 BMW or a 1982 Chrysler K Car.

The Insurance Audit

Ok, we have covered the bad news. The good news is that many reputable brokers have the skills necessary and are willing to conduct policy reviews at no cost. The typical quid pro quo is that if issues of significance are discovered then the broker is given the chance to implement those solutions.

Obviously, there are varying levels of review that can be conducted and each requires a different time commitment on the part of both the client and broker.

The easiest route for the client is to merely make complete copies of all of their insurance policies and provide them to the broker. If they are a private company and the broker is not familiar with the business the client should plan on spending time getting them familiar with their operations. The more time a client can invest in this process the more value they will get out of it.

The next level would be to provide copies of all the applications and schedules that were provided during the most recent renewal process in addition to the complete copies of the policies. Loss runs would also be very helpful. With this information the broker will be in a better position to evaluate the pricing as well as the gaps in coverage.

The third level would be a full risk management review and exposure analysis. This review can typically be done for a nominal fee that can be offset by any commissions a broker may receive if they were to be hired.

It would involve all the above information, plus complete copies of pertinent contracts and financials and interviews with relevant internal staff which could include, CFO, CEO, COO, Safety Manager, HR, Operations, Plant Management, etc. In essence, this would be a clean sheet review of your entire risk management and insurance approach. There are various levels of analysis that cannot all be described here. However, the foundation of risk management itself is the 5 step risk management process. The review will be rooted in the nuts and bolts of these 5 steps summarized below.

The 5 Step Risk Management Process

• 1. Identify Exposures: Identify all exposures to loss. Analyze what the odds are that the loss will occur (potential frequency) and the dollar impact it could have on the business (potential severity).
  
  
• 2. Evaluate Risk Management Alternatives: Broadly this involves looking at Risk Control, Risk Transfer and Risk Retention/Risk Financing techniques. Risk control and transfer techniques include loss avoidance, loss prevention, loss mitigation and transfer to 3rd parties. Any remaining risk then needs to be addressed through retention/financing techniques (which typically includes buying insurance). As a firm grows, however, there are more options to finance risk than just buying insurance. Here is where one needs to analyze the balance of self insurance vs. insurance. At this step loss forecasting or actuarial analysis may be required.
  
  
• 3. Select Risk Management Techniques: Through previously conducted analysis, one will now be in a position to weigh the costs and benefits of each approach and how they may fit with a firm's short and long term objectives.
  
  
• 4. Implement Chosen Techniques: As a firm becomes more complex the risk management techniques become more involved than just buying a policy. From loss control and claims management programs to the administration of self insurance these risk management techniques require effort and support on the part of management to insure that they are implemented effectively.
  
  
• 5. Monitor The Results. A good risk management program will establish goals, measure performance and benchmark the performance against the goals. Monitoring the results is critical in order to identify problems and to make adjustments as required. This is especially important for growing companies that may have less experience with risk management.

Whether it's due to a firm's growth or the performance of a service provider many insurance programs can leave a business exposed in ways they would not expect. The insurance audit is a low cost solution that can help correct this situation. In addition, if a firm would like to conduct a more comprehensive analysis, the risk management review can help take a firm's approach to risk and insurance to the next level.

If one is working hard to prepare the family business for the next generation or is part of the next generation stepping in, protecting the family business is a big responsibility. Following these simple steps will help ensure that the company is protected for many generations to come.

If you have any questions or need more information, please contact:

Mark Shoemaker
Account Executive, Sales
marks@barneyandbarney.com
(949) 544-8469

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