Big trouble for small businesses

By the time you put this magazine down, another handful of small businesses will have folded. The business pages may be dominated by corporate collapses, but it is the UK’s 4.7 million small and medium-sized enterprises (SMEs) that are bearing the brunt of the recession. With smaller pockets, they are more vulnerable to sudden credit crises and, as they are often at the end of a chain of suppliers, they are also the ones left hungry when everyone else is scrabbling to keep hold of their cash. BDO Stoy Hayward, an accountancy firm, predicts 30,000 will close their doors by the end of the year – 120 a day, or five an hour.

SMEs are the hidden powerhouse of the economy, contributing more than half of the UK’s turnover. According to the Department for Business, Enterprise and Regulatory Reform (BERR), they employ 9% of the private sector workforce. They are also the lifeblood of the commercial insurance market and contribute a sizeable chunk of insurers’ premium incomes – although that will inevitably decline as businesses fail and surviving companies have fewer people and lower turnovers to insure.

So it’s both a pressing concern and a genuine business opportunity for the industry to help SME customers survive. This is easier said than done, however.

By its nature, the SME market is diverse and fragmented. The government defines SMEs as companies employing fewer than 250 people, so the category ranges from larger manufacturers that spend £100,000 a year on premiums to one-person home businesses that buy an off-the-shelf package for a few hundred pounds. What they have in common is a reliance on credit that has suddenly dried up, and a desperate need to cut costs to survive.

Insurance is a somewhat intangible and little understood cost to a business, so is one of the first to come under scrutiny. The danger is that when scrapping policies or procedures deemed “nice to have” rather than essential, business owners will leave themselves even more exposed. Business interruption cover, for example, isn’t a legal requirement but it can offer vital protection against machinery failure or customers defaulting on debts.

Cost-cutting elsewhere in the business can also invalidate insurance policies – failing to maintain an alarm system or invest in training or maintenance, for example. Brokers must play a crucial role in educating customers and making sure they have the right cover. The hard part is how to do it.

The government found out how difficult it can be to reach out to SMEs when a £1.3bn plan to guarantee loans of up to £1m to the sector struggled to get off the blocks. The Enterprise Finance Guarantee scheme was launched in mid-January as an urgent response to the credit crisis, but a survey of 4,000 businesses by the Federation of Small Businesses two weeks later found that only 8% said their banks had made the borrowing facility available to them. BERR says that within the first five weeks the scheme lent a total of £40m to 400 businesses and that the pace should increase, though a spokesman admitted “it takes time for schemes to take effect”.

The insurance industry can expect to face the same challenges in reaching its many smallest customers. The good news is that companies are becoming more willing to talk about their needs. “SMEs are now making sure they’re not paying for something they don’t need,” says John Wood, a consultant who works for the Broker Network, visiting small businesses. “More people are knocking on the door. People who previously wouldn’t have gone out to tender or looked for alternative quotes more often than every five years are now doing it every year.”

The challenge is that small businesses really need one-to-one attention and it’s hard to see how it can be cost effective to offer that kind of service when the sums involved are so low. “Larger brokers’ consulting arms tend to lump SMEs in together and charge an arm and a leg. But smaller brokers don’t have the staff to go out and see every company,” says Wood.

John Grange, an adviser with the government’s Business Link advice service, makes 200 visits a year to 120 companies to help them develop. “Most SMEs are looking carefully at costs, including insurance. The insurance industry should be engaging with them and making people aware of what they offer. It’s a business opportunity for brokers to be a little bit more SME friendly – even more so in the difficult economic climate we’re in,” he says.

A few days earlier, Grange had been to visit a client with a turnover of just over £1m and a workforce of 20 people. To save money, the client had found a cheaper insurance package online, but the experience had not done anything to improve his perceptions of the industry.

“My client would have benefited by insurers talking to him, asking what his needs were, saying, ‘This is what you’re getting, this is what it does’. Brokers and insurers could help themselves by being a little more customer-centric. In any business, if you’re close to your customers you’ve got a far better chance of giving them what they want and being perceived as adding value.”

He admits that it can be hard work. “The paradox is that SMEs will be reluctant to pay for that service. People like myself and the insurance industry have an educating job to do. There isn’t such a thing as a free lunch. If you want clarity and peace of mind, you have to pay a little more.”

Philip Moody at the Forum of Private Business says the gap in the market is for businesses one tier above the micro-operations. As a senior member services representative, he’s well aware of the challenges its 25,000 members are facing – the number of credit-related calls it has received this year is up 50% on 2008.

“There are many comprehensive policies for small shopkeepers and that sort of thing but, once businesses get to a certain size, they can’t be compartmentalised and they do need an insurance broker. A lot of people in that area are very badly served.”

Planning ahead is one of the greatest difficulties for recession-hit businesses. Last July, the Institute of Chartered Accountants in England and Wales (ICAEW) conducted a survey of 1,020 companies, 40% of them SMEs. Seventy-two per cent of all those surveyed said this was the biggest challenge they faced.

“You need greater awareness of the risks a business is running,” says Clive Lewis, head of SME issues at the institute. “The survey was last summer, and it has become much more difficult to plan since then.”

Talk to any building contractor and you’ll get a vivid idea of the struggle to plan ahead. Construction is traditionally one of the first industries to feel the effects of recession, as Markham Jones, owner of 1st Choice Property Services in North Wales, can testify. He had built up a £500,000 business but his turnover last year dwindled to just £12,000, not even enough to pay his mortgage.

“Our work is practically non-existent. There’s been no work this week, there was no work the week before – the phone isn’t ringing. But we’re still paying the same for Yellow Pages ads and the same for insurance. I’ve only done two jobs since Christmas, but I still have to have insurance cover.”

Jones feels little affection for the insurance industry. “It’s ludicrous, frankly. We’re unable to pay the amounts demanded of us. My contractors’ all risks cover has been going up, even though I’ve never made a claim. It’s become so expensive that it’s almost impossible to build it into the cost of doing a job.”

He also finds it tricky to estimate his turnover upfront for insurance purposes. “It’s horrendously difficult to come up with how much work you’re going to do in this market. It’s OK when it’s an ‘up’ market ... you have more people phoning, you’re having to refuse work or you can put prices up. But when it turns the other way, it’s massively difficult.”

Brokers who do engage with their SME customers already have a tough sell, but it’s going to get even more difficult. Insurers are determined to reverse the premium price cuts of the past three years – terrible timing for SMEs trying to cut costs – and are becoming more sensitive to the probability of more claims from companies in trouble.

“If a financially healthy business loses a laptop worth £300 to £400, and they’ve got a policy excess of £250, they probably won’t bother claiming,” says Malcolm Smith, commercial lines director at Groupama. “But if a company is financially stretched, it’s more likely to make a claim for that sort of incident.” Claims increased in the second half of 2008, he adds.

In response, credit checks are likely to become a more frequent part of the underwriting process. “Like most insurers, we do this from time to time. Now we are thinking about whether we can embed some form of check to identify which companies are financially healthy and which aren’t, and adjust our underwriting so we can give better credit to financially healthy customers.”

As a result, SMEs already in difficulties will find their insurance costs even more.

Simon Cooter, distribution director at Brit Insurance, suggests insurers could also tailor their products more carefully to customers in straitened circumstances – “economy-type products, which just meet all the basic requirements, right through to all-singing, all-dancing products with additional cover and extra services, and insurers being transparent about the fact that the luxury product is going to cost more”.

Some firms have already seen the business opportunity in the SME market. As one of the world’s largest brokers, Aon might seem an unlikely friend of the little guy but that’s how it hopes to position itself with the “healthcheck” service it launched last October for companies spending more than £5,000 on their annual premiums.

“We go to SMEs free and see if their policies are fit for purpose,” says Gerry Callaghan, sales and marketing director for commercial focus. “We check that the scope of cover and sums insured are adequate, do a full audit to understand the SME’s business, and get reductions in premiums for them. One guy, a plumber who diversified into electrical work, hadn’t bothered to change the wording on his policy. He’d have been in real trouble if he’d had a claim.”

He says Aon is also “happy” to review policies from other brokers – rivals beware. There are 20 people on the healthcheck team; 13 handling renewals with existing clients and seven drumming up new business. Since October, it has visited more than 100 companies.

Clive Lewis at the ICAEW points out that a lot of new businesses are set up in a recession, as people are made redundant.

“They start on a part-time basis or do it very tentatively at first. Often, they don’t go into these things having done a huge amount of research and maybe don’t think of all they need to. If people are trading from home, for example, there will be insurance considerations.”

However brokers choose to approach the market, they can be certain of support from small business advisers. The message from the Forum of Private Business, Business Link and the Institute of Chartered Accountants will always be to get specialist advice.

“I think brokers have a crucial role at the moment,” says Lewis. “Businesses need to be thinking about the risks they face on a wide range of issues – the risk of bad debt, the risk of a customer defaulting, a supplier defaulting. An insurance broker should be one of those three telephone numbers you have programmed into your phone and call frequently for advice.”