Why SMEs need the right Human Capital Risk protection
Small to medium sized businesses (SMEs) represent over 97% of all businesses in Australia, which translates to over two million across the country. Of these, 85% have less than five employees.
For SMEs people are the business, which is why Human Capital Risk exposure is so significant. For the owner, your business relies on you, your employees rely on you and your family relies on you.
There are two ways to deal with business risk. These are:
• Control risk through:
Reduction – this may be achieved through documenting policies and procedures or re-designing the operational structure of the business.
Avoidance – means to remove the risk entirely from your business, such as not letting all Directors on a plane together.
• Finance risk through:
Retention/Part Retention – if business cash flows/balance sheet are strong enough, risks can be retained through budgeting or building up cash reserves.
Transfer – is normally the avenue of obtaining appropriate insurance.
Six reasons why SMEs have low resilience to Human Capital Risk
1. Size – Business owner’s personal assets and income are closely interlinked to the business. The loss of key people may not only result in the loss of the business but in the loss of the owner’s personal wealth as well.
2. Financial Weakness – Loss of key people will likely result in a lack of strength in the business balance sheet and cash flow. A financial shock can quickly lead to small businesses operating in an insolvent position, not having enough income to cover their outgoings.
3. Interdependence – If something happens in one part of the business there is often a domino effect that flows all the way through the business. So many individual parts of SME businesses are reliant on other parts and therefore interdependent.
4. Operational Structure – When the operational structure is mapped out, it is generally a couple of individuals performing the important and critical aspects of the business. So if we take one individual away from the business we are often removing functions that have an impact on the whole business.
5. Business Procedures – SMEs are notoriously bad when it comes to policies and procedures. It’s rare to find SMEs well documented and instead much of the business intellectual property is in the heads of the key people, which further adds to the reliance on them.
6. Attitudes – By nature SME business owners are entrepreneurial and risk tolerant. They have gone into small business as opposed to being an employee in an organisation. They have an underlying opinion of “she’ll be right mate”, a can do attitude and an ability to muddle their way through a problem. This creates a situation where they have very low awareness of risk and its impact, particularly from a financial context.
All of these traits lead to SMEs having a low resilience to Human Capital Risk. Low resilience means the lack of ability for a SME to recover quickly from the permanent or temporary absence of an owner or key employee. This results in the business not being able to quickly resume its original structure, profitability and operations, likely leading to the loss of clients and/or key contracts.
The question is about what to insure and what to retain and this is where specialist adviser groups such as Australian Financial Risk Management (AFRM) can help. SMEs are grossly underserved when it comes to addressing Human Capital Risks and risk management solutions.
SME Human Capital Risk protection statistics:
• 6% had buy & sell cover
• 8% had business liability protection
• 7% had key person protection
• 62% had business income protection
* Reported by Cameron Research, 2014
For us at AFRM this highlights two things. Australian SMEs are getting:
1. Advice that is not comprehensive; and/or
2. Poor quality advice which is not dealing with all the financial and human capital risks.
Risk management is good for business as it builds value and therefore saleability. It also allows key people/management to focus on strategic planning in order to grow the business, as well as having peace-of-mind should anything go wrong.