Rising insurance costs cut into profits

Rising insurance costs cut into profits – Brief Article

Ron Ruggless

As industry lobbyists press for congressional solutions, skyrocketing insurance costs are forcing restaurateurs to consider menu-price hikes and causing operators to issue warnings that their profits likely will be reduced in the year ahead.

“The costs are rising not only on liability insurance but also on workers’ camp insurance and health,” said Sam Manolakas, chairman of the California Restaurant Association and owner of the four-unit Brookfield Family Restaurant chain in the Sacramento, Calif., area. “Anything insurance related just seems to be going through the roof.”

Darden Restaurants Inc. of Orlando, Fin., in February warned that earnings in the third quarter, which ended Feb. 23, would be lower, in part because of insurance costs.

“We expect our thirdquarter earnings results to be adversely affected by several factors,” said Linda Dimopoulos, chief financial officer of Darden, which owns and operates more than 1,200 Red Lobster, Olive Garden, Bahama Breeze and Smokey Bones restaurants. “Workers’ compensation and insurance costs will be higher than anticipated this quarter.”

In the same week that Darden issued its warning, CEC Enterprises Inc. of Irving, Texas, operator of the Chuck E. Cheese’s pizza-and-games chain, cautioned shareholders that increasing insurance costs were likely to reduce profits in the year ahead. Rodney Carter, CEC’s chief financial officer, said in a conference call with investors and analysts: “With the losses from terrorist activities and everything else, the insurance companies have certainly been focused on restoring their financial condition as well. So there’s a lot of pressure throughout that industry on overall insurance costs.”

Indeed, analysts have attributed sometimes-steep hikes in many types of premiums to insurers’ efforts to offset massive stock-portfolio losses their industry has incurred as a leading institutional investor.

Many insurance operators, for their part, are considering how to deal with dramatic increases in liability, health and workers’ compensation coverage.

Menu increases are likely, Manolakas said. “It’s got to be a pass-on cost to the customer,” he added, because restaurant companies are reporting increases of 50 percent to 200 percent for workers’ compensation coverage and 30 percent to 70 percent for liability insurance.

“It’s a problem that just kind of popped up, so all restaurants are kind of at the mercy of the insurance companies,” he said. “I don’t think there is anything we can do immediately.”

Rapidly rising insurance costs could hamper margins industrywide, according to Mark Kalinowski, an analyst at Salomon Smith Barney. In a research report issued late last month, he cited warnings from Darden and Wendy’s International, which both lowered earnings-per-share targets and blamed those moves in part on insurance inflation.

“Our analysis indicates that the ‘average’ restaurant company’s pretax margins could be constrained this year by 50 to 100 basis points solely due to rising insurance rates,” Kalinowski’s report stated.

However, not all operators are at risk of insurance hits, he said. “Companies generating ample same-store-sales gains may be better positioned to fight off insurance cost pressures,” he wrote, citing “Starbucks and P.F. Chang’s China Bistro as the companies that best fit this description.”

Of the 11 restaurant chains that Kalinowsky’s team covers, the “average” puts insurance at 2 percent to 4 percent of its costs, he said, adding that “rates are rising by approximately 20 percent in 2003, versus 2002 levels.”

Restaurant companies insurance rate increases can vary wildly, his report stated. “For example, Jack in the Box looks for its insurance costs to be up by 40 percent year-over-year, while some other companies we cover, like P.F. Chang’s China Bistro, seem to expect increases of a much smaller magnitude.”

The potential of rising insurance rates is a risk for the entire foodservice industry, the analyst said, “and one reason why we are not at this time seriously considering an upgrade of the industry rating.”

For hard-pressed restaurant companies, remedial strategies are varied.

According to California Restaurant Association chairman Manolakas, “A lot of the larger [foodservice companies] are looking at self-insurance, especially on the workers’ comp issue, with an element of reinsurance in there.”

So-called self-insurance is a tactic employed by business owners who act as their own insurance companies up to a point, leaving an actual insurer to serve as a reinsurer. Although self-insurance is practiced in varying permutations, in general the employer absorbs the financial exposure and pays out claims on hospital-recorded employee accidents and injuries up to a certain maximum annual figure or aggregate.

Like a deductible on medical- or car-insurance policies that consumers pay before their insurers pay off the balance of a claim, the higher the annual aggregate amount of loss, or exposure, companies are willing to assume, the lower their insurance costs.

In some configurations self-insurance is “extra” coverage operators buy above a certain amount of deductible. In yet other variations a percentage of the average medical cost related to a specific injury is paid until a grand total is surpassed, triggering the insurer’s participation.

Manolakas recommended that restaurateurs ask their insurance brokers to seek out all applicable discounts. “It’s really a matter of education,” he added, suggesting that operators also consult their restaurant associations.

“On the workers’ compensation insurance issue, we have what we think are solutions. What’s needed in the state of California is drastic, drastic reforms,” he said. “There are so many [insurance] companies that have dropped out of the market.”

Offering a personal example of the problem, Manolakas explained that a year ago, when his restaurants sought bids for insurance, only two companies gave quotes, compared with the usual 10 to 12 firms that had bid on his business. “And the premiums were 100 percent more than a year before,” he said. “We’re holding our breath this year, because our renewal is in April ’03.”

The Washington, D.C.-based Insurance Information Institute has sought to put recent rate inflation in perspective. “When the stock market is doing well, [insurers] use their premium dollars to invest and use the capital accumulation from those investments to pay claims,” institute spokeswoman Carolyn Gorman said in an interview last fall. “When the stock market does poorly and investments do poorly, they have to increase rates to bring in capital. That is the business cycle we find ourselves in currently.”

Although some skeptics discount the impact of the Sept. 11 terror attacks as only a short-term rate-inflation factor, Gorman pointed out that insurers would be paying 9/11-related claims “for decades to come.”

In the area of health insurance for employees, the National Restaurant Association is pressing for federal solutions.

Brendan Flanagan, an NRA health-care lobbyist, said the association has made it a priority “to advocate on public-policy solutions that would bring down the cost of insurance.”

Flanagan went on to say that “Assisted Health Plans, in our view, are the best fix for helping contain health-care costs” and “would provide a good deal of savings.

“We also support tax credits that would provide more direct and short-term financial relief,” Flanagan added. “AHPs actually do what we think is needed, and that is to reform the actual health-care-insurance market. Right now in most markets around the country, small businesses just don’t have enough choices when they are out looking for affordable plans for their employees.

“In labor-intensive businesses like restaurants, which are highly competitive, offering a robust package is a key ingredient in finding and retaining good employees,” he continued. “It’s a huge priority of ours. AHPs would allow a business to look at a health plan that their trade association could offer,” which would provide “more economies of scale and administrative savings than they would be able to get on their own in the market.”

At a press conference on Feb. 11, where an AHP bill was introduced in the U.S. House of Representatives, NRA member Lynn Martins, who is owner of Seibel’s Family Restaurant in Burtonsville, Md., joined Secretary of Labor Elaine Chao and members of Congress to explain why she supports AHP efforts.

“Currently, I can afford to pay the insurance for only 10 of my 65 employees,” Martins said. “Over the last three years, my premiums have gone up 60 percent. This is simply not acceptable. I want to provide insurance for all my employees, but the cost makes it impossible. AHPs will allow small businesses to increase their purchasing power and will put health insurance within reach for more restaurants around the country.”

Steven C. Anderson, president and chief executive of the NRA, said, “Association Health Plans make sense for small business owners and their employees.”

Added Anderson, “We are also gratified to know the Senate will follow the House’s lead on AHPs and introduce companion legislation in the coming days.”

NRA lobbyist Flanagan said AHP legislation previously was passed in the House but stalled in the Senate. However, “the recent November election gave us some new supporters in the Senate, and President Bush has spoken out for it in the past year,” he said.

The need is great, Flanagan asserted. “Our surveys indicate that the average [rate increase] across table-service restaurants in just the past two years was 23 percent each,” Flanagan said. “However, we are hearing some members who are experiencing increases of 40, 50 and 60 percent. There are much worse examples.”

The increasing insurance premiums are likely to get worse before-they get better, Flanagan indicated. “All different types of insurance are key cost items for restaurants. We continue to work on property and casualty insurance as well.”

COPYRIGHT 2003 Reproduced with permission of the copyright holder. Further reproduction or distribution is prohibited without permission.

COPYRIGHT 2003 Gale Group