To read an underwriting guideline on insuring restaurants, one could easily come away wondering why anyone would ever open a restaurant or even eat in one, let alone insure it.

Compared to most small businesses, the hazards of running a restaurant appear almost staggering:

Clearly, restaurants are not just another small business. For insurers, even the simplest of restaurant operations presents a mix of exposures more complex and more risky than those of other small businesses.

Given that, property/casualty carriers who have been writing businessowners coverage may be understandably cautious about jumping into restaurant insurance now that restaurants have become eligible classes under standard “BOPs.”

AAIS added restaurants as an eligible class in the 2004 revision of its Businessowners Program.

Under the AAIS BOP, restaurant operations up to 7,500 square feet and $3 million in annual receipts per location are eligible risks, provided they derive less than 25% of their annual revenue from sales of alcoholic beverages.

A big market

For all the risks they pose, there are compelling reasons why restaurants have become an eligible class under standardized BOPs, and why standard commercial lines carriers should at least consider insuring them.

Most importantly, restaurants constitute a huge industry.

According to the National Restaurant Association (NRA), there are some 878,000 foodservice locations in the United States accounting for $440 billion in sales, an amount equivalent to 4% of the U.S. gross domestic product.

Also, with an estimated 12 million workers, the restaurant sector is the nation’s largest employer, according to the NRA.

Standard commercial carriers can compete for a surprising amount of restaurant insurance business available.

Despite the growth of large restaurant chains, “more than seven out of 10 eating and drinking establishments are single-unit (independent) operations,” according to the NRA.

Even though large restaurant chains may have proprietary insurance programs, those programs don’t necessarily hold a monopoly over independent franchisees.

Tony Guptaitis, president of Spillman and Wotyla, an agency in Glen Ellyn, Ill., says that he was once able to lure several hamburger chain franchisees from a proprietary program to an independent program he was marketing, and that he once had 80% of the northern Illinois franchisees of a chain of doughnut shops.

A growing market

Not only are restaurants a large market, they are growing rapidly as “eating out” becomes a regular American past time.

Restaurant sales have grow more than 7% per year since 1970, according to the NRA, twice the real rate of GDP growth. The restaurant industry now accounts for nearly half of U.S. expenditures on food, up from a quarter in the 1950s.

Apart from the sheer magnitude of these numbers, the figures suggest that the hazards confronting restaurants are readily managed.

The fact is, despite all the hazards listed at the outset of this article (and more), the number of restaurants in the U.S. has managed to grow almost exponentially, and people patronize them virtually without hesitation. That wouldn’t be happening if the hazards were consistently disruptive.

Observers almost never fail to note that restaurants have the highest “mortality rate” of any industry that requires comparable amounts of start-up capital. Perhaps a third or more go out of business within three years.

That’s a sobering observation to underwriters who understand that safety and maintenance suffer when money is tight.

But there is a flip side: The restaurant business is a churning one, where new independent and franchise operations are apparently born faster than the failing ones die, regularly creating new account opportunities for carriers willing to insure them.

In all, “[the restaurant market] has been a solid market for the last few years, with industry forecasts for continued growth,” says Mike Modlin, product director for commercial business for Fireman’s Fund Insurance Group, a leading restaurant writer.

Reliable loss ratios on commercial market niches are hard to come by, as the information is generally proprietary. A 1998 article in Rough Notes magazine stated that eating establishments had a loss ratio of 60.2%, according to Insurance Market Research, Morris Plains, N.J. More recent public sources could not be found.

That figure is comparable, if not lower, than loss ratios for commercial multi-peril insurance overall. But, if sources for this article are any indication, insurers who want to be successful in writing restaurants should be prepared to accept higher underwriting expense ratios.

Many office and small processing exposures can be--and often are--underwritten on the basis of information submitted to a carrier or managing general agent without any inspection by agents or underwriters.

If there is anything that sources for this article agreed on, it is that restaurants have to be seen and inspected to be underwritten properly. In most cases, that means partnering with an agency with experienced people capable of doing frontline underwriting.

“A lot of BOP underwriters don’t understand that restaurants are more risky,” says Brian Cruz, president of the Restaurant Insurance Group, Sacramento, Cal. In Cruz’s opinion, fully one-third of restaurants are not acceptable risks, but the only way to distinguish between the acceptable and unacceptable is to have someone inspect the risks.

When asked what he would advise a carrier considering restaurants for the first time, Cruz replied: “Try to find an underwriting agent who controls a book of business in a region.”

Tellingly, Cruz adds: “I’ve never seen a [restaurant] program profitable on the national level,” an indication that centralized underwriting is not enough to manage this class.

Carriers sometimes err in the restaurant market by implementing unnecessarily prohibitive underwriting standards while failing to inspect for real hazards, says Steve Passow, an underwriting agent with the Colorado Restaurant Insurance Agency who spent 30 years as a restaurant operator.

For example, Passow says, some companies place a strict limit on the age of a structure in which a restaurant is located. That addresses real concerns about fire hazards, but “other companies don’t pay attention to the age of the structure as long as the updates have been done” to cooking, heating, electrical, and other systems, he says.

Walking around

Whatever underwriting guidelines you put in place, say those with experience in the market, there is no substitute for personal inspections of establishments and rigorous scrutiny of those running them.

Sources for this article singled out four characteristics of a restaurant risk that they considered pre-eminently important:

• A state-of-the-art fire suppression system in the kitchen, with air ducts that are kept clean to allow smoke to exit. Apart from the obvious dangers of fire, a successful restaurant operation must control losses from smoke that can occur even in the absence of a serious fire.

• The experience of its owner-operator. Insurers often require the operator to have at least three years experience in the business, but Guptaitis says it is not hard to find operators with far more experience than that, as many new operators have extensive experience as employees of restaurant chains.

• The personal finances of the owner-operator. The depths of the personal pockets of an independent owner-operator may make the difference between a good risk and a bad one, says Passow.

• Maintenance and housekeeping. “There have been some [restaurants] that, when I walk in, I walk right back out again” because of poor upkeep, says Guptaitis. Passow, too, puts great stock in housekeeping, finding it to be a strong indication of the owner’s attention to hazards.

“If the producer cannot provide the necessary information, then inspections will likely be required, thus driving up expenses.”

“To achieve profits in this class of business, tolerance for higher underwriting ratios is necessary,” says Dina Widlacki, AAIS senior product development specialist for commercial lines, who has underwritten restaurants and other food service operations in her years as an underwriter.

“The combination of slips and falls, food-borne illnesses, and chipped tooth claims drive up loss costs for small [bodily injury claims].With underwriting results driven by small loss costs, there is going to be very little funding for the large losses.”

Product and claims

All that notwithstanding, now may be the most propitious time in years for carriers to enter the restaurant market, as that market has hardened after some carriers have left it.

“People tend to get in and out of this business,” says Paul Bremer, director of pricing for Farmers Insurance, another leading restaurant writer.

Anyone entering the market will still find established players who have developed customized policies for restaurant risks.

For example, Farmers offers “Premier” and “Primary” coverage packages for restaurants that include built-in coverage for spoilage, customers’ property, crime exposures, parking area liability, and other exposures.

Cruz of the Restaurant Insurance Group advises BOP writers to develop extended coverage package endorsements to provide additional coverages for exposures such as food spoilage, safekeeping of valuables, and others.

Bremer and Cruz add that restaurant business requires a more assertive approach to claims than other BOP classes.

“If you want to succeed in this class, you have to have a very strong claims department,” says Bremer. “It’s an industry where you have frequent losses. You have fires, slips and falls, chipped teeth, and more.”

BOP carriers that want to write restaurants successfully must put aside the reflexive emphasis on closing claims and not be quick to settle, says Cruz.

“At least half the claims could be adjusted lower or denied altogether,” he says.

In sum, many carriers write restaurants with a BOP: Farmers, Fireman’s Fund, St. Paul Travelers, Zurich, and others, according to Bremer.

“Anyone who is doing it real well is doing it on a BOP,” says Guptaitis.

But successful restaurant writers don’t write restaurants like a BOP; that is, like just another BOP class. They write them with appropriate attention to the unique hazards restaurants face.

“If you take the time to study the industry, study losses, and study which accounts can offer potential, you can make money,” says Bremer.