Staying on Top of FDD Requirements for Risk and Insurance

It’s hard to escape the continuing boom in restaurant franchises. Quick-serve brands are leading the trend, and not just for restaurants, but for franchises overall. 

But it’s not just newbies to franchising – or restaurant franchises themselves, for that matter – that need to stay on top of the management intricacies that characterize the business. The pressures extend beyond balancing higher costs in an inflationary environment or the never-ending challenge of finding, training and keeping good staff. 

Even experienced operators know that navigating the compliance requirements laid out by each state’s franchise registration rules isn’t easy. Just as challenging is keeping on top of federally mandated franchise disclosures contained in the Franchise Disclosure Documents (FDD). 

Either way, both franchisors and franchisees alike need to be aware of the nuances that can be unclear, especially in the FDD, which is a complex document. What may be overlooked within it are risk and insurance issues.    

The FDD Explained

A lot has been written about the FDD, much of it directed to prospective or new franchisees so they know what to expect or to look for in its pages before buying in. But it’s relevant to a broader audience, too.

With 23 sections, the FDD spells out the franchisor’s track record and requirements on a multitude of fronts, from finances (including three years of statements, owner’s equity and cash flow), franchise fees, litigation and more. It should be updated regularly, and that can be time-consuming, especially for growing concepts.

Many franchisors have dedicated staff in charge of maintaining the FDD, although tech solutions are increasingly available, offering efficient, integrated and customizable tools for managing insurance and compliance requirements.

And there’s a lot of value to that. The FDD is a “living” document, a valuable playbook for franchisors and franchisees. Tech solutions aside, it makes sense for all franchisees to pay attention to its contents. Risk and insurance should be top on the list.

The Complexities of Franchising Risk and Insurance Requirements

Franchisors are required to develop and maintain a risk management plan that goes beyond the commercial to operational risks and establishes the tools to manage them. This covers requirements such as robust recruitment parameters, franchisee training and continuing support, performance monitoring and a formal franchise dispute management process.

In terms of insurance, FDD guidelines for requirements are complicated; language over specific coverages, limits and other matters can vary substantially. Certificate tracking and compliance are crucial. Franchisees must specify the franchisor as an additional insured. Quality insurers and the right coverage count, as well as the amount of coverage, should expand as the franchise does.

And it’s worth noting: it’s important to have an experienced insurance broker acquainted with the nuances of franchise insurance.

Key Insurance Lines

The insurance marketplace has been under pressure for several years, from an availability perspective of certain lines and cost. But experienced franchisees know that stinting can violate their franchise agreement. 

Here’s an overview of key lines for the industry:

  • Umbrella: “Excess” coverage outside the limits of other policies is among the most pressured. But skyrocketing claims for situations like active shooter events make it essential. Premiums are up by as much as 300%, carrier capacity is tight, and their coverage limits are vastly reduced. Brokers are having to go to the excess and surplus market to get the franchisor-required limits.
  • Catastrophic property: Franchises in coastal regions vulnerable to natural disasters such as hurricanes and flooding are most affected by this difficult market. Pricing is escalating and previous coverage limits no longer make sense to insurers.
  • Employment Practices Liability Insurance (EPLI): Outside of a few states like California, this market is softening somewhat. Insurers are more open on terms and conditions, though retentions have increased. One of the tougher aspects of EPLI for hospitality is wage and hour violations as litigation, especially in restaurant franchises, which drives premiums up.
  • Directors and Officers (D&O), Errors and Omissions (E&O): Both lines should be bundled and are particularly important for franchisors. D&O covers leadership defense costs and damages, particularly in play against franchisee litigation. E&O, or professional liability, picks up for competitor or vendor legal action. 
  • Cyber: The market has softened for cyber but it’s hard to convince hospitality franchises that their exposure is real. Cyber crime is a big risk for the industry, though, and not just due to hacking, but vulnerabilities from social engineering manipulations like phishing attacks.
  •  Liquor liability: This continues to be a tough placement for many hospitality establishments selling liquor, depending on the state and its laws on who can be served and over-service issues.