Franchisors Supersize Cost Savings with Captive Insurance

Today's franchise operators are struggling for survival like never before. With a competitive landscape with a constant stream of new players, pressure to add trendy menu items, gaps in the supply chain, and the tightest labor market in decades, franchises are beyond eager for help. 

Consider how your favorite franchise location might appear from an insurer's perspective: high employee turnover, low-skill workers operating fryers, increased risks of slips and falls, and the constant need to adhere to food safety regulations. The lobby often features kiosks for ordering and self-service beverage centers where spills are frequent. Walk-up customers compete for space with impatient drive-thru patrons. It's no surprise that franchisees are facing double- or even triple-digit premium increases in general liability, property, and umbrella insurance—if they can even find an insurer willing to cover them, as many are exiting the restaurant sector entirely.  

The challenges franchisees face when securing liability insurance highlight the impact of nuclear verdicts in US courtrooms and the tactics designed to pressure them through prolonged court cases. 

Establishing a captive insurance program is an effective way for franchisors to ensure their franchisees have access to high-quality insurance coverage that is both better and more affordable than what the current market offers. This approach also creates financial incentives for initiatives like worker safety programs that reduce claims while offering the potential for tax efficiencies and access to stable coverage. 

Many franchisors help their franchisees increase profitability through group purchasing programs. Developing a captive insurance program works in a similar way: it brings together a large group of owners, establishes actuarially sound funding levels based on their specific business risks (not an industry average), and provides focused support to reduce the frequency and severity of claims. 

One of the keys to a successful captive insurance program is the scale of what's being insured. The more top-performing franchisees who participate, the better the data and the greater control the franchisor can exert over claim reduction efforts. To attract most fronting insurers and reinsurers, the captive typically needs at least $3 million in total premium volume. 

The growing flow of private equity money into the franchise industry raises a critical issue that franchisors and franchisees should address early in the captive conversation. When a private equity group takes control of a franchisor, its focus is often on maximizing returns over 5 to 7 years before selling to another company or group of investors. When that happens, who owns the captive? Franchisees might assume they do, given their contributions to fund it, but unless ownership is clearly defined in the documents, they could find themselves insured by a former owner with no ongoing stake in their success.

The franchisor must also begin with the end in mind. Is the goal to establish the captive insurance company as a member-owned initiative, or is the primary objective to create a new revenue stream from franchisees? What are the tax-related goals, and who should benefit? Decisions like these will shape how the captive is structured and operated. 

Franchisee education is a critical component of exploring and pursuing a captive insurance strategy. Business owners, often focused on short-term performance and expenses, need guidance to adopt a longer-term perspective. Most franchise systems have a franchisee advisory council that represents franchisee concerns and communicates essential business decisions. Educating council members is an effective starting point for introducing the concept of a captive insurer. Involving them early can help preempt potential resistance from the larger group of operators and allow them to contribute meaningfully to the design of the captive plan. 

The key message they can convey is that transitioning to a captive offers both immediate and long-term benefits. In the short term, franchise operators won't need to scramble for coverage; they can expect cost efficiencies, pricing consistency, and coverage tailored to their specific business realities. Over time, the captive's investment in claim reduction activities will lead to significant reductions in overall insurance costs. Additionally, efficiently funded and well-managed captives can create a financial reserve. Franchisees can use their share to enhance their balance sheets through dividends, increasing the value of their businesses when they decide to exit. 

While the captive strategy offers numerous advantages, it also involves complexities, such as selecting the appropriate domicile and ensuring regulatory compliance. For this reason, franchisors considering this approach should partner with a captive expert experienced in helping other franchisors maximize the benefits.