Franchise Insurance: Understanding Risks and Relationships

Every franchise owner has decisions to make about insurance. How many decisions, and how complex the options, depends on the industry and the franchisor. 

One of the most important insurance decisions a franchise operator can make is in selecting an agent or broker. Whether you’re a franchisor or a franchisee, it’s critical that you work with an insurance professional who has a thorough understanding of two factors: 

1. The relationship between franchisor and franchisee; 
2. The risks and exposures inherent in the franchise’s industry. 

Let’s start with the franchisor-franchisee relationship, terms of which are set in the franchise agreement. Every business within a franchise bears at least some resemblance to its fellow franchise members, but while some franchisors exert extensive control over franchisees, others allow a good deal of autonomy.  

Auto franchises, for example, typically exercise massive oversight of their dealerships, requiring their mechanics to be trained and certified by the manufacturer. Restaurant chains typically dictate menu offerings and food-preparation procedures. But there are many franchise establishments in the United States — more than 785,000 as of February 2020, according to the International Franchise Association — and some exert relatively little control after the owner pays the franchise fee and signs the franchise agreement. 

Whatever your franchisor-franchisee relationship is, the insurance firm and representative you work with to design your customized coverage is entirely up to you. 

10 Essential Coverages  

Most franchise businesses should have protection in the form of these 10 basic insurance coverages:   

• Property — Commercial Property Insurance covers your business’ physical location or equipment, including computers, documents, furniture, inventory and tools, if it is damaged, destroyed or stolen. 
• General Liability — Coverage protects both the franchisor and the franchisee from personal injury if a customer is injured on the premises due to an accident such as a slip and fall. 
• Directors and Officers (D&O) — Also known as Management Liability Insurance, this protects directors, officers and managers from lawsuits and financial harm arising from mistakes or wrongful acts while managing the business. 
• Employment Practices Liability — Following the rise of the #MeToo and Black Lives Matter movements, COVID-19 and vaccination requirements have raised the importance of Employment Practices Liability Insurance (EPLI) to unprecedented levels, including among franchises. EPLI protects against lawsuits by current, former and prospective employees for claims such as sexual harassment, discrimination, wrongful termination and more. 
• Product Liability — If your franchise manufactures, distributes or sells products, you need this coverage to protect you from legal liability resulting from a product defect that caused personal injury or property damage. Product Recall Insurance is advisable as well. 
• Excess Liability — In the era of nuclear verdicts in liability lawsuits, Excess Liability Insurance is frequently necessary to provide coverage beyond the limits of a General Liability policy. 
• Commercial Auto — This covers both damage to the vehicle and liability for accidents involving cars, trucks and vans used for business purposes. 
• Equipment Breakdown — From ovens to refrigerators to computers, this covers losses caused by electrical or mechanical breakdown on business equipment, including repair and replacement costs resulting from damage caused by the breakdown. 
• Loss of Business Income — Also known as Business Interruption Insurance, coverage protects you against events that prevent or hamper your ability to do business due to events beyond your control, such as natural disasters and structure fires.  
• Cyber — Cybersecurity is an issue that affects both individual franchise businesses and overall brands. Some franchisors have policies that cover all franchisees, others require franchisees to purchase their own coverage, and others don’t require it at all, believing the cost outweighs the risk to a small business. The latter view is naïve, at best.  
• Workers’ Compensation — If an employee incurs physical injury resulting from an accident or exposure to disease while on the job, Workers’ Comp covers resulting loss. 

Franchisor Considerations 

If you’re a franchisor, have you adequately protected yourself by insuring and/or transferring risk? As the online hub Small Business Trends notes in its August 2020 article “Franchise Agreement: 20 Important Things to Know”: 

“The franchise agreement will include the requirement for the franchisee to maintain certain insurance coverage throughout the term of the franchise. Expect indemnification clauses, as well. For example, the franchisee will probably be required to ‘indemnify, defend and hold harmless’ the franchisor against any claims, costs, damages and expenses arising out of the franchisee’s activities.” 

Yet there’s still more to consider. What, if any, franchisee risks do you assume? What, if any, coverages do you require franchises to provide themselves? Do any uncovered exposures remain? 

Franchisee Considerations  

If you’re a franchisee, what, if any, coverages does the franchisor provide? What coverages does the franchisor mandate in the franchise agreement? Are those coverages enough to fully protect your business from all the risks and exposures you face – some of which may be very different from those faced by a franchisee of the same brand but different location? 

A McDonald’s restaurant in the heart of New York City’s Chinatown, for example, would require different coverage compared to a McDonald’s doing exclusively drive-through business, which would have different coverage needs compared to, say, the McDonald’s housed in an 18th century Greek Revival mansion in Freeport, Maine. 

Similarly, the risks facing a franchise restaurant are largely different from those facing the franchise tax-preparation franchise right next door, which is where your insurance professional’s knowledge of your industry is vital.  

Agent/Broker Considerations  

That specialized knowledge also informs the agent’s or broker’s insight into what solutions would be best, in regard not only to appropriateness of coverage but also to affordability.  

The ongoing hard market for property and casualty insurance has generally meant decreased availability, increased underwriter scrutiny, higher rates and lower limits — though the extent of those effects varies from industry to industry, location to location and even business to business. Claim histories are one key determinant, but so are industry volatility, regional weather and other exposures, such as product liability or the use of delivery drivers. 

Consulting with a knowledgeable, experienced agent or broker will enable you to determine whether alternative means of coverage, such as a captive insurance program, is your best option. If not, economy of scale might make a franchise or consortium of franchisees eligible for a national program with a traditional insurance carrier.  

Again, it takes an insurance professional who understands the franchisor-franchisee relationship and the franchise’s industry — as well as the property and casualty market — to inform you of the options available and advise you as to the best solution for your business.  

How Peers and Competitors Are Responding to COVID-19 

No industry or business, franchise or otherwise, has been immune to the effects of COVID-19. Throughout the pandemic, Alera Group has conducted national employer surveys to determine how business of various sizes, industries and locations are navigating employee health, benefits and human resources issues, including: 

• Talent attraction and retention 
• Mental health 
• Work-from-home, hybrid and return-to-work policies 
• Vaccination. 

We conducted our most recent survey from October 18 to November 4, and the results are now available in a comprehensive, user-friendly report, “COVID-19 Employer Pulse Survey, Part 3.” We’ll discuss the results in a one-hour webinar on Thursday, December 16, and we invite you to join us. You’ll gain valuable insight to how other organizations are responding to the HR and benefits challenges you and your business face. 

DOWNLOAD THE REPORT 

REGISTER FOR THE WEBINAR 

About the Author 

Griff Gatewood
Associate Vice President
Lighthouse Group, an Alera Group Company 

Griff Gatewood and his team develop commercial insurance, Surety, and alternative risk management strategies centered around the needs of businesses in the construction, manufacturing and security industries throughout the Midwest and beyond. 

Contact Information: 

• griffith.gatewood@aleragroup.com 
• (616) 455-1652 
• Connect with Griff on LinkedIn