Why Restaurant Franchises Make Good Program Business

One industry segment ideal for the program market and somewhat immune to the effects of a battered economy is the fast-food, multi-unit restaurant franchise industry, the experts say.

The larger a company grows, the slower its rate of growth. But that’s not true for many franchise operations. The largest franchise systems — including the crown jewel of the fast-food restaurant industry — keep getting larger and larger, according to the Franchise Times’ Top 200, an annual industry ranking of the largest franchise systems in the country.

One of the largest franchise systems in the world — McDonald’s Corp. — grew 11.1 percent in sales in 2012, or $8.6 billion. The multi-unit McDonald’s Corp. operates a total of 33,510 units worldwide (14,098 domestic units and 19,412 international units) and 81 percent of those unit stores are owned by franchise operators. The Golden Arches grew its unit count by 2.4 percent in 2012 alone.

While McDonald’s stands as the biggest fish in the sea of fast-food franchises, it’s not the only fish worth insuring, the experts say.

Throughout the economic crash of 2008 until today, fast-food franchises have stood the test of tough times, says Everett R. Newman, Jr. program director and managing partner for United Alternative Risk Insurance Solutions, which manages the Restaurant Franchise Captive Program (RFCP).

Newman helped launch the RFCP in July 2004 with Travelers Insurance Co., which serves as both the fronting carrier and reinsurer for the captive program. York Risk Services handles the claims.

Over the program’s almost 10-year history business has been good, Newman says.

“We are working on the renewal right now,” he says. “We’ve been very fortunate that Travelers has been with us for the 10 years and they are certainly offering a renewal.”

That’s because the program overall has been very profitable. “Our historical loss ratio in the program is just under 30 percent for nine years,” Newman says. “It’s very profitable for Travelers and the members of the captive.”

RFCP insures a number of recognizable national name brand fast food franchises, including Carl’s Jr., Wendy’s, Baja Fresh, KFC, Cinnabon, and many others. The program offers workers’ compensation and a package policy that includes all property lines of coverage and liability coverage.

In recent years, Newman and other specialists in the restaurant franchise segment have seen a surge in opportunities to insure multi-unit franchise operators.

“There’s been a real growth in the number of multi-unit franchisees, or franchisees with 20 or more locations since the economic downturn of 2008,” Newman says. “The number of larger franchises has grown significantly since 2009 and a big part of that growth has to do with the availability of capital for larger franchise operators.”

Larger franchise operators are better equipped to buy corporate stores when they become available or to buy smaller franchise operations that maybe looking to sell, he says.

A big trend, according to the Franchise Times Top 200 report, is that franchise corporations have become more reluctance to grow and operate corporate-owned stores. That means more corporate stores have become available for individual franchise owners to buy.

In the Franchise Times’ first Top 200 ranking in 2006, 79 percent of the locations of Top 200 brands were operated by franchisees. However, in 2012, franchisees owned 88 percent. “In other words, the company-owned unit count was cut nearly in half, from 21 percent to 12 percent,” the report said.

Refranchising Trend

Some of the growth in new franchise operations is due to refranchising, or the sale of company-owned stores to franchisees. Between 1999 and 2006, the number of company-owned stores grew by 16 percent. But since the end of 2006, company store count on the Top 200 has plunged 22.4 percent as corporations shed 16,671 locations.

Numerous companies in the Top 200 ranking, especially restaurants, have engaged in some form of refranchising, including McDonald’s, KFC, Burger King, Pizza Hut, Taco Bell, Jack in the Box and Applebee’s, the report said.

McDonald’s company-owned unit count has declined by 5 percent over the past five years, by 1,731 restaurants. Jack in the Box sold off 641 units in that time, while Applebee’s owner, DineEquity, shed 339 units, according to information from Piper Jaffray, an investment bank and asset management firm.

This “refranchising” trend is opening new doors for program administrators, carriers and brokers targeting this segment.

“There’s always somebody that thinks they can open a restaurant,” says Richard Lewis, an agent with the R.H. Clarkson Insurance Group based in Louisville, Ky. “Restaurants are the most often opened businesses and the most often closed businesses, so there’s always opportunities.”

Lewis, whose agency works with the many McDonald’s franchisees, is seeing new franchise operations open all the time. From Qdoba Mexican Grills to gourmet grilled cheese shops, there’s always a new franchise opportunity, he says.

R.H. Clarkson has been working with the McDonald’s insurance program since the early 70s and has the availability to write locations in all 50 states, Lewis says.

While his agency writes franchise restaurants brands ranging from Dairy Queen to Papa John’s to Texas Roadhouse, no other corporation has the insurance program in place the way that McDonald’s does, according to Lewis.

McDonald’s approves the insurance companies that provide the package policy to a franchise operator, he says. The corporation has specific coverage guidelines in place including policy form guidelines, and insurance company financial strength guidelines. “They have to be ‘A-minus’ (excellent) and (financial) size category of IX rated before they can be eligible for the program,” Lewis says. “Carriers also have to have their forms submitted and approved by McDonald’s.”

That’s because McDonald’s requires a replacement cost form that doesn’t include an actual limit on a store, Lewis says “It’s replacement cost. You would never see that actual replacement cost, guaranteed replacement cost without a limit on any other policy. You are not going to run into a Wendy’s or Taco Bell that has guaranteed replacement cost. They all have a limit.”

While there are several carriers approved to work with the McDonald’s insurance program, retail agents are only approved to write under one carrier for the package policy, Lewis says. “We bring in one carrier to the plan and that’s how that works,” Lewis says.

“Everybody in the program purchases workers’ compensation, and then of course the package with the business owner’s policy,” Lewis says. But only the package policy must be written with the approved carrier. Other coverages, such as employment practices liability insurance (EPLI), umbrella, or other lines of coverage don’t have to be approved by McDonald’s, he says.

Janice Cavanaugh-Teti, partner in the American Franchise Specialist Agency Inc. (AFSA), a nationally recognized insurance broker specializing in insurance programs for franchises, also works with the McDonald’s insurance program.

Cavanaugh-Teti and her partner founded AFSA 24 years ago after working on McDonald’s franchise accounts for another company. “I’ve been doing McDonald’s ever since,” she says.

Cavanaugh-Teti says that while McDonald’s has approved insurance companies and approved brokers that write for those companies, franchise operators can deviate from that list as long as they comply with minimum coverage requirements required by McDonald’s Corp.

But when it comes to other restaurant corporations, coverage requirements vary significantly from franchise to franchise, she says.

“All these franchises, every one of these franchises, they’re all going to have their own requirements,” she says. “Some may want $10 million liability; some may only want $5 million.”

Unlike McDonald’s Corp., many franchise corporations do not require approval of specific insurance programs, says Roy Mahlstedt, executive vice president of programs for Arch Insurance Group. He says the extent of their involvement depends on the attitude of the franchise grantor.

“Many chain restaurants have little interest in becoming involved in franchisee coverage except to the extent of ensuring that corporate interests are protected by reviewing policy language, or requiring the corporate entity to be covered as additional insured or via indemnification,” Mahlstedt says. “Should the franchisor wish to be involved, there are contractual and financial methods to induce their franchisees to participate in a corporate sponsored or endorsed program.”

Specialty Coverages

Insuring franchise restaurants can be similar to insuring a typical mom-and-pop restaurant, the experts say. Standard coverages for property and liability all apply, but franchise restaurant operators also need a few specialized coverage endorsements that some insurance carrier don’t offer, says Scott Wink, general partner for CRW Insurance & Financial Services based in New Holstein, Wis. he says.

Some of the insurers CRW represents offer what’s called a “franchise endorsement,” which allows a franchise owner to update their location to new franchise corporation standards should there be a loss, such as a fire.

“If it’s a Burger King, for example, and they have a fire loss, now the franchise agreement says, ‘If you have a loss, you are now required to update your store,’ maybe if they changed the branding,” Wink says. “They may require the franchisee to now inject a large amount of capital to come up with a new color scheme or whatever it might be because they had a loss.” The franchise endorsement provides coverage for that, he says.

Another area sometimes overlooked is coverage for indirect power outage and the limitation in distance, Wink says.

“A lot of companies will have a distance limitation of 1,000 feet or whatever it might be for a power outage. If I have a restaurant and a substation starts on fire three miles away and takes out a whole grid, most companies would exclude coverage because of the distance limitation,” he says. “You want to be with a company that is unlimited, where if a substation starts on fire three miles away you still have coverage.”

Wink says it’s important to have a policy or program that’s detailed and tailored to the coverages that a restaurant franchise needs.

“The franchise endorsement, no waiting period in the loss of income, no distance limitation on the power outage … those are things that can make a big difference to a restaurant.”

Franchise Market

In most instances, restaurant franchises make an ideal fit in the program insurance market, says Dave Strunk, national underwriting director for CNA’s small business programs team.

CNA writes many franchise programs, including restaurants, Strunk says. “We write some of the largest restaurant franchises in the country, in the world, for that matter.”

Strunk says the fast food franchise space is perfect for programs. “You find a lot of similarity. It’s a very homogeneous group. If you have a sandwich shop chain and they have good standards as a company, you’re going to find the same types of exposures and controls, from an insurance and risk management perspective” in all locations, he says. “You’re going to have the same types of operation and hopefully the same management philosophy.”

Restaurant chains, like McDonald’s, make an underwriter’s job much easier, he says.

“You know exactly what your experience is going to be when you go into a McDonald’s,” Strunk says. “From an insurance underwriter’s perspective, that’s good. You want to know what you’re insuring.”

When franchise companies operate hundreds or thousands of locations around the country, it’s difficult for an underwriter or broker to visit each location, Strunk says. “You can’t visit every single one of them,” he says. “You have to make some assumptions as to the quality, as to the controls, and if you have a strong franchisor who clearly articulates how they manage their business, closely controls that, it gives you that consistency of exposures and controls.”

Phil Cameron, chief marketing officer for SPARTA Insurance, says most program specialists would agree that when it comes to gold-standard restaurant franchises, McDonald’s operates as best-in-class. That alone makes it a highly-targeted risk among brokers and program administrators. But overall, the restaurant franchise segment is a good class for program insurers.

“Overall, I think the restaurant franchise business is more in the middle to lower end of severity classes, putting property exposure and Tier 1 aside,” Cameron says. “It’s a lower hazard class of business so I think a lot of other carriers do target this class.”

SPARTA, which stands for “Specialty Program and Risk Transfer Alternatives,” launched in 2007 with the idea that there was a gap in the marketplace when it came to insurers focused 100 percent on the unbundled program and captive marketplace in the U.S. “And right from the get-go one of our targeted classes of business were restaurant franchises,” said Bill Murphy, program underwriter for SPARTA’s franchise fast food program.

Murphy says the segment is competitive. “In the general franchise restaurant space, we do see a number of players, brokers and carriers competing pretty regularly. It’s good business, if you have the right partner and the right program.”