Risk management can help you make money or protect you from losing money. In a November 2008 Inside Self-Storage webinar, Paul Cardamon and I talked about risk management in the self-storage business. This article begins to explore what risk management is and looks at some of its standard tools.
The recent ISS webinar addressed two types of risk: speculative and pure. Pure risk deals only with the opportunity for you to lose, or at best, maintain your financial position before a loss. This is the type of risk dealt with by the insurance industry.
Speculative risk, on the other hand, is what most of us think about when we think of risk. It’s the ability to make or lose money, based on a number of factors including chance and our personal risk tolerance. Examples include investing in the stock market, betting on a horse race or starting a business.
Why is speculative risk important and what does it have to do with running a self-storage company? Its relevance has to do with the distinction between a “known” risk and an “unknown” or “unintended” risk. Examples of known risk include: Is my property up to code? Is it well maintained? Do I have adequate security? Unknown or unintended risks include: Am I over-leveraged? Do I have the right kind of insurance? Who do I have working for me?
Speculative risk may involve some of the same analysis, but the chance element is more like gaming than the insurance business. When we deal with “pure risk” in the insurance business, it is based on a large body of experience and we can assign probabilities of loss that translate into premiums.
While we can’t predict the exact time, place or financial impact of any one loss, the insurance industry can set a price to accept the risk based on the law of large numbers (i.e., the number of building fires for a specific area over a given time period for a specific type of construction, and their resultant financial losses). The insurance industry measures probability, frequency and severity of a loss to determine how best to fund that loss (using premium), to bring you back to where you were financially before the loss.
The Five Tools
Risk management is the practice of applying tools developed to reduce the chance of loss. Properly applying these tools helps reduce the disruption a loss causes your business while helping keep the costs of insurance reasonable.
In self-storage, risk-management concepts apply not only to your buildings, roofs and driveways, but also to your maintenance practices, property security, operational procedures, records management, hiring practices, safety procedures, financial controls, disaster-recovery plans and lease language.
Over the years, the insurance industry has developed five tools for managing pure risk:
1. Avoidance. This is the simplest of the tools. If you see an opportunity that’s too risky, that you don’t believe is worth pursuing, run—or at least walk quickly—away from it.
2. Control. This tool recognizes that you have some level of risk and applies logical, prudent business practices to control the risk. For example, if you have a site manager who rents units, sells ancillary products, and collects rent and late fees, you should have written procedures in place explaining what the manager is supposed to do and what he’s accountable for; and an audit process that verifies and balances receipts, bank deposits and inventory.
Your lease is another control element, protecting you against your customers by identifying your responsibilities as well as theirs. It should state tenants can’t store flammable liquids or contraband, can’t live in their units, etc., and that they have to pay rent on a certain date every month. You get the idea.
3. Non-insurance transfer. This is a simple concept with a basis in contract law. It says that two parties can decide who is responsible for certain actions. It also is a concept found in your lease—your insurance requirement. Most self-storage leases have language naming tenants as responsible for insuring their property, and you (the landlord) are not responsible for loss or damage to their property. It also adds that should you be responsible (if you’re negligent), your liability is limited to the amount specified in the lease, usually $2,000, $2,500 or $5,000.
The insurance requirement is a critical piece in your defense that you are a landlord, not a warehouseman. It supports the “exculpatory” language in your lease (the words that say you are not responsible for loss or damage to the tenant’s property) especially in the large number of states where courts do not recognize exculpatory language. Assuming liability for tenant’s property may sound like a great marketing tool but may well expose you to one or more unintended risks.
4. Insurance. This is a transfer of potential financial loss to a regulated third party—someone who has the financial resources to do so. Making sure that you have the right kind of insurance is important. The insurance industry has developed specific policies to protect you with coverages including:
- Tenant insurance
- Customer goods legal liability insurance pays for your defense in negligence suits as well as judgments
- Pollution clean-up coverage pays for remediation when a tenant leaves a unit full of toxic waste
- Sale and disposal legal liability insurance for when you’ve sold the contents of the wrong unit in a lien sale
- Business-interruption insurance with an extended period of indemnity replaces your lost income while re-leasing after a disaster.
In addition, you may need industry standards like boiler and machinery coverage if you offer climate control or have elevators in a multi-story building.
5. Retention. This represents the amount of financial loss you are willing to absorb. Your deductible is the simplest example. In the process of trading a higher deductible for a lower premium, you’re also recognizing that insurance is only one of the tools you use to run your business. It’s your hedge against financial loss—laying off a small amount of money that can help you recover when a disaster strikes.
Risk management is not a difficult concept. On the operations side of your business it most often involves keeping your eyes open, looking for things that can hurt people or cost you money and applying common sense. On the insurance side it means working with a professional who knows and understands your business and can provide the right kinds of policies needed to protect your investment.
Bob Bader is the founder and CEO of Bader Co., as well as the director of the National Multi-Housing Council. He has more than 35 years of experience in the insurance industry. Bader Co. offers commercial and tenant insurance programs that best fit the objectives of self-storage owners and their management companies. For more information, call 888.223.3726; visit www.baderco.com.
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Professional Liability Insurance
Self-Storage Insurance: Changing With the Times
