3 Risk-Management Challenges Family-Owned Businesses Face and How to Solve Them
There's no denying the importance of family-owned businesses to the economy and workforce, yet it's family-owned businesses that often have the most to lose.
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Family-owned businesses have tremendous impact on the global economy. According to recent data for 2021 by researchers from the University of North Carolina and Kennesaw State University sponsored by Family Enterprise USA, family-owned businesses contribute 54% of private sector GDP in the U.S. or $7.7 trillion and are responsible for employing 59% of the private sector workforce accounting for 83.3 million jobs.
There's no denying the importance of family-owned businesses to the economy and workforce, yet it's family-owned businesses that often have the most to lose:
- Family businesses are more likely to face employment-practices liability claims and director and officer liability. These issues can be exacerbated by a lack of business planning and company policies.
- Family-owned businesses — especially small businesses — are financially less equipped than their Fortune 500 brethren to weather the storms of risks like supply-chain disruption, pandemic-related challenges, intellectual property theft, loss of a key employee or cybercrime-related loss.
- These businesses also face higher risk from natural disasters since their locations or inventory are often geographically concentrated.
The question is, how can these risks be mitigated? There are three key challenges when it comes to risk management for family-owned businesses and small businesses.
- It's difficult to insure against the risks these businesses are most likely to face. It's possible, but the issue is that commercial insurance, particularly for the specific risks noted above, is often cost-prohibitive and difficult to obtain.
- Many family-owned businesses and small businesses are uninsured or underinsured: 75% of businesses are underinsured and 40% are insured for risks according to a survey by Insureon. Many business owners or executive teams do not review their insurance policies and are also not aware of exclusions. They may think they're covered when in reality they're not.
- Surviving these threats requires having the funds to sustain the business until they're resolved. A Goldman Sachs survey of 1,100 small businesses found that a whopping 44% have less than three months of cash reserves, leaving them vulnerable to crises or risks.
There's a solution that addresses all three of these challenges: Businesses can choose to own their own insurance company, known as a captive-insurance company. Not only does a captive-insurance company establish a more robust risk-management approach, placing the business on better survival footing, but it enables the business owner or business to own a profitable second business. The profitable business can help lower commercial insurance costs, build up loss reserves and prevent the total business entity from being hollowed out by excessive taxation.
Related: 5 Keys to Successfully Leading a Family Business
Family-owned businesses that have achieved sustained economic success and amassed a significant asset base should consider captive insurance as part of a smart business-continuity model. These three questions can help family businesses determine if they are ready to consider captive insurance.
1. Do you meet the criteria to own a captive-insurance company?
For a captive insurance company to be a good fit for your business, the most important question to ask is whether your business can be interrupted. For example, if Covid were to happen again or another catastrophe — be it a natural disaster, terrorist attack or rioting — struck, could it prevent your business from being able to operate? When it comes down it, the most detrimental risk to a business is interruption, and often times, commercial insurance won't cover this.
There are many different kinds of risk that can either create an interruption or be costly, and captive insurance is uniquely suited to cover them. If you can answer a "yes" to any risks on the following list, then captive insurance is worth considering for your business:
- Loss of a key supplier.
- Loss of key employee.
- Cyber attacks.
- Intellectual property theft.
- Natural disasters.
- Utilities, machinery or technology failure.
- Environmental hazards.
- Regulatory compliance.
- Reputation damage.
- Staff sickness/absence.
- Transportation delay or damage.
- Terrorism, war and political unrest.
- Increasing healthcare costs.
In addition to assessing risks and taking business interruption into account, typically a minimum of $3 million or more in revenue and 10 or more employees is a good starting point for owning a captive-insurance company. Businesses should also be run with an eye towards mitigating losses.
Related: Technological Advances Bring New Cyber Risks. Here's How to Mitigate Them.
2. Do you have un- or under-insured risks?
A good starting point is to sit down with your senior team and conduct a risk assessment and determine the risks your business is most likely to face. Then, look at your insurance plans and conclude whether the risk is insured or not insured against. If it is insured, it's also important to go a step further and look for policy exclusions and make sure it's not under-insured. When under-insured, a business can still be responsible for a large percentage of total loss.
In this same vein, it's also helpful to look at how much the business is spending on insurance and how much control the business has over this. The hardening of the insurance market has made acquiring insurance costly. This doesn't just apply to mitigating risk, but can also apply to employee benefits. For example, health insurance costs for employers continue to rise, and industry studies show that employee benefits can account for over 35% of payroll expenses. Captive insurance can be an effective financial strategy for reining in and controlling sky-rocketing healthcare costs.
3. Can you benefit from asset protection?
Far too often businesses will accumulate wealth, but then fail to protect it or to plan and prepare a safe and effective transfer of the wealth to their children or grandchildren. This succession and estate planning are often concerns for family-owned businesses. Avoiding unexpected losses by insuring them with a captive provides peace-of-mind, making it easier to have a succession and keep the business strong during a crisis. Also, a well-run captive-insurance company will amass liquid funds, and all business succession is more effective to achieve with liquidity than without liquidity.
For family-owned businesses that can say "yes" to the above three criteria, captive insurance can be a beneficial alternative or supplementation to third-party commercial insurance and robust risk-management practices. After all, according to the Family Business Alliance, only about 30% of family-owned businesses make the transition into the next generation, so it behooves these businesses to explore solutions that can strengthen their business and ensure longevity and future success.
Related: 4 Secrets to Highly Successful Family-Owned Businesses