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How to Select the Right Insurance Coverage for Your Restaurant

By the time you open your doors, you will have developed relationships with several vendors, including your food and beverage purveyors, equipment sellers, and advertising representatives. You'll know where to get the best price on quality meats and have a file folder full of wares suppliers. As in our personal lives, business folk often look at insurance as a last-minute detail, and you probably won't shop as carefully as you should.

While insurance will not bring more guests to your door or improve your service and fare, securing proper coverage from Day One will help you sleep well at night. And believe us, in the startup-and-growth phase of the restaurant business, you'll welcome the rest.

Most restaurant owners and managers become quite skillful and knowledgeable when it comes to stocking their pantry and freezers. Ask them about buying their insurance program, however, and they get a pained look on their face and you get the impression they would rather avoid it. Part of the pain has to do with the price of insurance. This is especially true the past few years as businesses have seen significant premium increases. The question of the day is how do I get the most out of my premium dollars and what do I look for when buying insurance for my restaurant? This article will explore these issues so you can make informed purchasing decisions when it comes to your restaurant insurance. It will also provide checklists of the types of information the insurance agent will want to know to get you the best deal on your policies.

Property Insurance

Property insurance is "first-party" coverage, meaning that it covers property that you own or are required to insure as part of a lease agreement, such as tenant improvements. Your property coverage is limited to the amount of coverage purchased, such as $400,000. This is the most the insurer would pay in the event of a total loss. Exclusions for earthquake and flood are common, and separate insurance is usually required for these perils.

Some items to look for when purchasing your property insurance are the coinsurance clause and replacement cost. The policy's coinsurance language requires the insured to purchase coverage for his property, up to some stated percentage of the property's replacement value. For example, if your policy has a 100 percent coinsurance clause (most policies are 80 percent, 90 percent or 100 percent), you are required to insure 100 percent of your replacement values. Let's assume your 100 percent replacement values are $400,000 and you have $200,000 in coverage. Since you are only 50 percent insured to value, you will only receive 50 percent of any loss even if it is below the policy limit. That is, if you have a $50,000 claim, you will only receive $25,000 less your deductible, because you are only 50 percent insured to value. I recommend you ask this clause to be waived. Oftentimes this can be done if you sign a statement of values attesting that you are insured to 100 percent of values.

The replacement cost clause covers your property without any deduction for depreciation. This is a common coverage and readily available. Usually this is included, but you must be sure it is in your policy by reviewing the coverage. Restaurant insurance underwriters look at specific items when underwriting and pricing a restaurant risk for property coverage.

• The age and condition of the restaurant building. The newer the better.
• The type of construction and roof.
• For older buildings, improvements in the electrical or plumbing.
• If the building is sprinkler equipped, the adequacy of the system must be documented. This is typically done by a sprinkler contractor.
• The cooking equipment extinguishing system is reviewed for adequacy. Many insurers require a UL 300-approved system. This system is adequate for lower fat content in vegetable cooking oil used in today's restaurants.
• Adequate space between deep-fat fryers and stove gas flames.

You should be aware of these underwriting requirements to make your restaurant a "preferred account," i.e., get the best premium rates. If you enter into a lease agreement, we recommend you ask your insurance agent to review the insurance requirements before you sign the lease. There may be situations where the lease requirements can be negotiated to keep your insurance costs as low as possible.

Business Income/Extra Expense

If your restaurant has to close down after a covered property loss, such as a fire, then you will lose income, which can be covered by your insurance program. This covers your lost net income and ongoing expenses. Coverage can be written two ways. First, you could have a limit such as $250,000, which is subject to coinsurance, typically 50 percent. Coinsurance for business income works the same way as coinsurance in property insurance. Today, many insurers write unlimited business income coverage with a time limit, typically 12 months. In this case the insurer will pay the actual loss sustained subject to a time limit. Once the time limit expires, the insurer has no further liability. It is worthwhile to note that some insurers have increased their period to 15 months.

General Liability

General liability insurance typically covers premises liability, products and completed operations and, in some cases, liquor liability. This includes accidents on the premises such as slip-and-falls and hot liquid spills. Products and completed operations liability covers allegations from foodborne illnesses in your products. Liquor liability covers you for liability arising from the serving of alcohol to your customers. Some states have stricter liability issues when it comes to alcohol. Some states put much of the liability on the restaurant, while others put much of it on the patron. Also, your general liability coverage includes coverage for libel, slander and false arrest. Typical exclusions are injuries to employees, employment practices liability and pollution.

These are some of the underwriting considerations used when pricing and evaluating your general liability exposures.

• What about housekeeping? Are floors clean and well maintained?
• What is the percentage of liquor sales? Once liquor sales exceed 40 percent to 50 percent of total sales, underwriters take a more conservative view of the risk. They will want to know if there's entertainment, happy hours, security and alcohol awareness training for employees.
• How many years of restaurant management experience does the owner have? New restaurateurs should have experience in the field and should have documentation, such as a resume to provide to insurers. Some insurers will not write new restaurant ventures.
• Is there any catering, and if so, how much? Is there valet parking?
• What is the claims history?

Automobile Insurance

If your restaurant is involved in catering or delivery, you have an automobile liability exposure even if your employees use their own car in your business. If the restaurant owns any vehicles, then a commercial auto policy should be written for the vehicle(s). Moreover, if employees use their vehicles in your business, you could be held responsible if they cause an accident while working for you. This can be covered by including "nonowned automobile coverage" on your auto policy or general liability policy if you don't have an auto policy.

Commercial automobile insurance underwriters will want to know the following information when pricing and selecting commercial auto risks.

• Age and driving records of all drivers, including number of years licensed.
• Radius of operations.
• Use of vehicles (i.e. delivery, catering).
• Past claims.

Crime Coverage

Restaurants have a crime exposure that includes robbery, on and off the premises, and employee dishonesty (employee theft). In pricing and selecting this risk, insurers will want to know the following.

• How much cash is on or off the premises at any one time?
• How often are bank deposits made?
• Who reconciles the bank accounts?
• Who can sign checks?
• In what type of area is the restaurant located?

Other Considerations

The insurance coverages discussed so far are considered common coverages that most restaurants should have in place. In fact, if you are a tenant, your lease agreement probably requires most or all of these coverages. Some of the other coverages that should be considered are Employment Practices Liability (EPL), Pollution Liability and Equipment Breakdown coverage.

EPL coverage provides protection from employee lawsuits such as sexual harassment, wrongful termination, discrimination and other employer wrongful acts. When underwriting and pricing this coverage, insurers want to know information about your workforce.

• When was your employee handbook last updated? You will need to have a handbook to be eligible for this coverage.
• What is your employee turnover history?
• Do you have a sexual harassment complaint policy? (In the restaurant business you should have this in place even if you do not have EPL coverage.)
• Questions regarding performance evaluations, job descriptions, "at will" wording on applications and termination procedures must be answered as well.
• Past claims in this area are scrutinized and all details must be disclosed.

Pollution liability is a less common coverage, but restaurants have an exposure when disposing of grease waste. If this waste is not disposed of properly, and it gives rise to a claim, beware; I have seen insurers try and deny coverage based on the pollution exclusion in the general liability policy.

Equipment breakdown coverage protects you for loss of equipment and income if you have an accidental equipment breakdown. Water heaters, kitchen equipment, HVAC equipment and other restaurant equipment can accidentally break down and be a cause of loss for your restaurant. The major exclusions for this coverage are wear and tear and normal maintenance.

Insurance is One Aspect of Risk Management

Your insurance program is just one aspect of overall risk management. Risk management includes other steps, such as identifying and analyzing the loss exposures you face. For example, a restaurant with a club upstairs that has live or recorded music and dancing would identify loss exposure differently from a family restaurant serving only beer and wine without a bar or lounge area.

Once you've identified your exposures, determine how to address them. These options usually include buying insurance, eliminating the exposure, or retaining the risk. Despite your overall insurance program, you should practice these risk management techniques on a regular basis.

• Establish an employee handbook and update it annually.
• Establish a safety program including safety training.
• Maintain and periodically service all fire suppression systems, including fire extinguishers.
• Always maintain good housekeeping in front and back.
• Provide alcohol awareness training.
• Establish proper food handling procedures.

While these steps sound theoretical, small-business owners do this all of the time. A good example is EPL coverage discussed earlier. Some restaurant owners do not want to pay the cost of this coverage ($5,000 to $15,000 per year) so they retain the risk and work with their attorney to institute an employee handbook, sexual harassment policy, and careful "at will" wording on their employment applications. (See "Don't Leave Mad, Just Leave," in the June 2004 issue.) These are risk management techniques that are used by small businesses every day.

Just know that risk management is not a static process. You need to monitor your decisions over time, and make changes where necessary, including purchasing more insurance to keep up with changes and growth in your business.

How Much Insurance Should You Buy?

This is actually a two-part question. The first part would be how much property insurance to buy. When buying property insurance, you should add all of your insurable values together. For example, your insurable values may look like this.

This is the amount of insurance you should have on your property coverage.

Business income insurance is a little more complex, but I will try to simplify it as much as possible. Your business income limit equals your gross profit, less expenses that would stop after a loss closes the restaurant. An example of an expense that would stop would be payroll, certain supplies and anything else unique to the restaurant business. Therefore, your business income limit of insurance could look like this.

Remember, in the earlier discussion regarding business income, many insurers are going to pay an "actual loss sustained" with a time limit. In this case a limit of insurance would not be required.

The second part of this question refers to general liability insurance. I recommend at least a $1 million-per-occurrence limit with a $2 million aggregate. An aggregate is the most the insurer will pay during the policy period. Most lease agreements require this as a minimum amount. Higher limits of liability are available for an additional cost. I advise restaurant owners to analyze a worst-case scenario for their business, and what this could lead to in potential liability damages.

Based on this analysis, I may recommend excess liability coverage. This is often called an "umbrella liability policy." Restaurants with entertainment exposures, or multiple locations, often need higher limits. In these cases, I would recommend a $5 million or $10 million excess liability limit.