Just in case you were wondering, I've lived through this nightmare. A dryer fire put our business down for 74 days and taught me everything you are about to read.
In our last blog we discussed disasters and best practices for how to make sure you are covered in case of an unpredictable loss. Remember only 60% of small businesses reopen and half of those close shortly thereafter which means you have a 30% chance of survival.
Now we’re going to talk about what actually happens when you have a loss at a small business and exactly why there is only a 30% survival rate after a major event.
How insurance companies make money
Let’s go back to the beginning. You open a business; you shop for insurance for liability, contents and business interruption. You call a few insurance companies and get some quotes. They ask you questions about what you do, how much revenue you are bringing in and the value of your contents that you want covered. They ask you all of these questions so that they can place you into a risk category and then they base your premiums on a formula based on the amount of possible insurance payout and the risk of them actually paying it out.
This makes sense right? Insurance is a calculated risk spread across thousands and thousands of clients. Premiums are collected from thousands of clients and a handful of them actually have a claim in a given year. It’s very possible that the claim is more significant that the premiums paid by the ONE client but when washed across all clients, it only represents a small percentage. The insurance company then pays for their overhead, labor costs, supplies etc.. And claim a profit on what is left over just like any other business on the planet. In an ideal world for an insurance carrier, they would collect premiums from all clients and never have a claim. However, this is the real world and fires, floods and other accidents happen all the time. That’s why insurance companies have a business in the first place.
Insurance companies know that there will be claims so they have to set up standard insurance contracts and operating procedures that legally outline what they are responsible to pay. It’s their responsibility to pay out as little as legally required to their clients. Let me say that again. It is their responsibility to pay out as little as legally required to their clients. This effectively immediately pits the small business owner against their carrier instantaneously in the case of a claim.
How do insurance companies get away with paying as little as possible while still claiming to be on the side of their client who has just had a major disaster? I’m glad you asked. There are a few fun games insurance companies play.
Basically this means that you are entitled to your profit plus your expenses.
We’ll get back to this…
When your business is operating at a normal level, you receive money each day and you pay bills each day. These bills include payroll, utilities, business loans, payments to suppliers, phone bills, and credit card swipe fees from the previous 30 days. If you miss any of these payments you’ll begin to get notices pretty quickly letting you know what will happen if you don’t pay. BTW they have already assessed the late fee and will tell you that after 60 days, they will report you to credit bureaus and damage your credit score.
When you have an event such as a fire or flood, your insurance company will agree to give you a fraction of what is owed immediately. They will then take 2 weeks to assign an accountant to your claim and the accountant will THEN have 2 weeks to review your numbers. This means that you are at least 4-5 weeks out on payment if things go smoothly.
If you have damaged contents that need replaced to reopen, you can expect the turnaround on the funds to be approximately 30 days out. This means that you either have to spend your own funds and wait for reimbursement OR you have to wait a month to order your tools and supplies which pushes out your reopen date an additional month and injures your business even further.
Since you are also cash flowing all of the bills and payroll while they assign an accountant, you may find cash flow to be impossible which means you run the risk of losing employees or damaging your finances in addition to the loss of clients you will experience during the closure.
Remember, you can only lose employees and clients while closed. It’s impossible to gain them when you aren’t open.
Remember the language in #1? Basically your policy says that you are entitled to your profit plus your expenses? Seems pretty clear right?.....Wrong!
This is the point of the process where the accountant that has been assigned to you after 2 weeks begins to demand all of your documents. They’ll ask for years of taxes, income statements, balance sheets, account statements etc… They will then input these figures into a handy dandy spreadsheet that has been designed to look for any way possible to deduct from what is owed.
Let’s pretend that your business grosses 100,000 per month and you are out of business for 1 month due to a fire or flood.
There will definitely be costs that you will not pay due to closure. You may not owe rent as per your lease. You won’t pay for supplies, credit card swipe fees or other direct costs associated with doing business. That’s fair.
However, you’d be surprised to find all of the other line items that your insurance company will attempt to deduct.
The insurance company will compare this year’s revenue to the previous 12 months. If they spot a weakness in revenue during that frame, they will deduct a percentage from revenue. If they determine that you are running 10% off of the year before and you happen to be closed for the month of May, they will simply take last May and tell you that it’s going to be 90% of last May. 100,000 in revenue from last May magically becomes 90,000 this May. This is some of the most arbitrary BS I’ve seen. Any business owner worth his salt knows that business isn’t linear. BTW if you’re business is running at a 10% premium over the prior May, I will guarantee that your carrier won’t pay you on “assumed increases” in revenue. This game only works backwards.
Now that your revenue is at 90% of last year, it will then be assumed that many other expenses will follow suit. Insurance, cleaning, sales tax, workers comp and others will all be multiplied by 0.9. Last I checked, I wasn’t able to tell my cleaning lady that I was only paying her 90% because we only made 90% of the normal dirt.
But wait….there’s still more
They will then put you on a cash basis for expenses that exceed their expectation during the period of restoration. Let’s say that your normal insurance payment is 1,000 per month as an average. However, your policy renews each May and so you are required to pay 2,000 in your may payment just like last May. The handy dandy forensic spreadsheet will dictate that you paid extra for your insurance so you are only entitled to the average for 12 months which is 1,000. Essentially, all line items that are overpaid are not reimbursed. They call this “Extra Expense” and this requires special approval.
If you underpay a budget, you won’t get that reimbursement either. Let’s use the same example and say your usual insurance payment is 1,000 but you pay 9 months out of the year and then get 3 off with your policy renewing in June. Therefore, you didn’t have a bill in May. Yep…you got it, they’ll try to hose you on that one too.
OK….we’ve now subtracted revenue based on a 12 month run rate, eaten away at usual expenses based on the reduced revenue and then gotten hosed by being put on a cash basis and an accrual basis whenever your carrier saw fit.
Not even close….
Those of you small business owners out there who pay attention to your taxes know that the tax code has changed a bit lately regarding meals and entertainment. It used to be that 50% could be deducted but the law has now changed so this is no longer a deductable line item. Regardless of the tax implications, the fact of the matter is that business owners will very often apply reasonable meals and entertainment expenses to their business expenses.
There are only 2 choices an owner can make with this line.
1) They pay themselves a salary, pay some taxes and then buy their work coffee or lunch for their partner, client, or attorney.
2) They pay for their work coffee out of the company and reduce their salary by the cost of the cup of coffee.
The point here is that this is a normal and expected expense and it is either an expense or part of payroll.
Just because the business is closed for a period of time doesn’t mean that business owners stop buying coffee or cease taking their accountant, attorney or other clients to lunch. Business continues to go on behind the scenes just like any other time of the year.
In the case of a fire, this is another line that will magically disappear. I’ve seen insurance companies arbitrarily apply an 85% deduction to this line item claiming that it is not a “continuing normal operating expense”. Good luck finding anything about this deduction in your policy. Trust me…it’s not there. Deducting it is straight up theft.
Please make it stop!!!
Now that all of those lines have been deducted, we take a quick flyby on your payroll. Have any subcontractors? Yeah they will try to hose you on their payroll as well.
Here’s the issue. Employee vs. Subcontractor is delineation for tax collection purposes. In certain scenarios, I can completely understand why a subcontractor wouldn’t be covered in the case of a fire. In other’s it makes absolutely zero sense.
Remember….the insurance company is tasked with making their clients “whole”. Essentially this means that they are returned to their previous state before the “event”.
Let’s take the example of a massage therapist who is also a bartender. The therapist works for a small business a few days a week and bartends on Friday and Saturday nights. The small business she works for has a fire. Technically the therapist doesn’t have to be paid as an employee due to the rules of subs vs. employees but she has been with the company for over 5 years and depends on the income of 1,000 a month to pay her bills.
The small business has a fire and closes for 30 days. It’s too short of a time frame to get another job but yet she’s not compensated by the employer because they aren’t compensated by their insurance carrier.
And then there is interest. Remember when you were supposed to bring in 100,000 during the month and it took the carrier over a month to cut the check? In order to keep everything going, a good business owner accesses credit cards and other lines of credit. Yay!!! You got to pay interest on this amount for the entire month!! Let’s call it 2K in interest.
There is a very real chance that is takes much longer than 30 days to wrap up so you get to pay 2K for EACH month that you are waiting for your reimbursement.
Has the small business and this employee been made “whole”?
What do you think?
So let’s check the scorecard. First let’s review the actual language in the policy you paid for:
This is pretty simple language. Pay me what I’m used to bringing in during the period and let me pay the bills and run my business. It’s even fair to subtract things that aren’t paid for while closed like CGS or swipe fees.
By my count, 29,000 has been “saved” in our example and we managed to screw every subcontractor that we will be relying on to reopen our doors and rebuild our client base.
Your insurance company will drop you because present more “Act of God” risk than the guy next door.
So what can you do? Act’s of God are named this way for a reason. There is little you can do about lightning strikes, fires, floods or other unpredictable events that threaten your business.
I speak from experience in the words above. I lived through an event and subsequent insurance battle and won. I you are experiencing an issue like this, I'd love to hear what's going on. I've set aside some time in my schedule for a free strategy session. Just click the link below and we'll make it happen.