Property and pecuniary risk exposures: An investigation into SMEs' shutdown and mitigation methods in Nigeria

Adeyele, Joshua Solomon; Osemene, Olubunmi Florence; Olubodun, Idowu Emmanuel Article Property and pecuniary risk exposures: An investigation into SMEs' shutdown and mitigation methods in Nigeria The Journal of Entrepreneurial Finance (JEF) Provided in Cooperation with: The Academy of Entrepreneurial Finance (AEF), Los Angeles, CA, USA Suggested Citation: Adeyele, Joshua Solomon; Osemene, Olubunmi Florence; Olubodun, Idowu Emmanuel (2017) : Property and pecuniary risk exposures: An investigation into SMEs' shutdown and mitigation methods in Nigeria, The Journal of Entrepreneurial Finance (JEF), ISSN 2373-1761, Pepperdine University, Graziadio School of Business and Management and The Academy of Entrepreneurial Finance (AEF), Malibu, CA and Los Angeles, CA, Vol. 19, Iss. 2, https://doi.org/10.57229/2373-1761.1306 This Version is available at: https://hdl.handle.net/10419/197542 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc/4.0/ The Journal of Entrepreneurial Finance Volume 19 Issue 2 Fall 2017 Article 1 July 2017 Property and Pecuniary Risk Exposures: An Investigation into SMEs’ Shutdown and Mitigation Methods in Nigeria Joshua Solomon Adeyele University of Jos, Jos-Nigeria Olubunmi Florence Osemene University of Ilorin, Ilorin Idowu Emmanuel Olubodun Elizade University, Ilara-Mokin Follow this and additional works at: https://digitalcommons.pepperdine.edu/jef Part of the Accounting Commons,Entrepreneurial and Small Business Operations Commons, and the Insurance Commons Recommended Citation Adeyele, Joshua Solomon; Osemene, Olubunmi Florence; and Olubodun, Idowu Emmanuel (2017) "Property and Pecuniary Risk Exposures: An Investigation into SMEs’ Shutdown and Mitigation Methods in Nigeria," The Journal of Entrepreneurial Finance: Vol. 19: Iss. 2, pp. No business is immune against property damage such as fire outbreak and building collapse in all countries of the world. The chance of any of these perils occurring is even higher in developing countries, particularly in Nigeria due to use of substandard materials by many building contractors who will not see the need to take material warranty insurance that enables the establishment of quality assurance in those structures. For such buildings used for SMEs’ businesses, whenever any of these perils operate, the operators need to reinstate their businesses if there is already set aside funds for that purpose or the perils are insured by insurance companies (Boland, Collins, Dickson, Ransom & Steele, 2004). If neither of these is in place, and there is no other reliable means for reinstatement, the affected SMEs will experience business shutdown. The implication of this to individuals and the society at large is clear. Workers will be laid off and economic wellbeing in the society where the businesses operate will be negatively affected. However, if these events were insured, the insurance companies will only be responsible for the reinstatement costs and employees will still be laid off, and profit to be earned during reinstatement will be lost (Wildman, Garvey, 2008, Wright & McNamara, 2000). This loss of profit and the cost of keeping employees while reinstatement takes place can be avoided through interruption insurance which ensures Property and Pecuniary Risk Exposures: An Investigation into SMEs’ Shutdown and Mitigation Methods in Nigeria Cover Page Footnote We wish to appreciate the efforts of Mrs. Adejoke A. Adeyele and 400 Level Actuarial Science and Insurance students (2016/2017 Session) of University of Benin who assisted in data collection. We also thank the SMEs' owners for their understanding and cooperation with our research assistants by validating the authenticity of data collected through phone calls. This article is available in The Journal of Entrepreneurial Finance: https://digitalcommons.pepperdine.edu/jef/vol19/iss2/1 Property and Pecuniary Risk Exposures: An Investigation into SMEs’ Shutdown and Mitigation Methods in Nigeria BY 1Joshua Solomon Adeyele, Ph.D., University of Jos, Jos, Nigeria. Olubunmi Florence Osemene, Ph.D. University of Ilorin, Ilorin, Nigeria Idowu Emmanuel Olubodun Elizade University, Ilara-Mokin, Nigeria ABSTRACT Business Interruption (BI) insurance is not popular among the operators/owners of Small and Medium Enterprises (SMEs) in Nigeria. This study is an attempt to investigate causes of SMEs’ failure and to assist the owners on how to use BI to protect both the physical assets as well as future profits of their businesses. Hence, 389 SMEs were purposively selected from four major cities in Niger Delta Region (NDR) in Nigeria for this purpose. The statistical tools used for analysis were Phi and Cramer’s V. The extent of SMEs losses through means of sourcing for materials and strategy employed to transfer such risk to third party were considered in this study. The findings revealed that: SMEs’ losses were strongly related to means of conveying raw materials to business locations; and responsibility assumed by SMEs’ owners to distribute goods to customers without the use of insured vehicles/vans. The study recommended among other things that SMEs’ owners can reduce some business risk exposures by making sure that their goods are carried on insured vehicles/vans, and that they can devise means to make the SMEs’ suppliers responsible for safe delivery of all materials purchased from them. Keywords: Business interruption, risk exposures, property and pecuniary insurance JEL Codes: D81, L26 1. Corresponding author: Mobile Number: +2348081485346 Email: [email protected].uk I. Introduction No business is immune against property damage such as fire outbreak and building collapse in all countries of the world. The chance of any of these perils occurring is even higher in developing countries, particularly in Nigeria due to use of substandard materials by many building contractors who will not see the need to take material warranty insurance that enables the establishment of quality assurance in those structures. For such buildings used by Small and Medium Enterprises (SMEs), whenever any of these perils occur, the operators/owners need to reinstate their businesses if there is already some set aside funds for that purpose or the perils are insured by insurance companies (Boland, Collins, Dickson, Ransom & Steele, 2004). If neither of these is in place, and there is no other reliable means for reinstatement, the affected SMEs will experience business shutdown. The implication of this to individuals and the society at large is clear. Workers will be laid off and economic wellbeing of the society where the businesses operate will be negatively affected. However, if these events were insured, the insurance companies will only be responsible for the reinstatement costs and employees will still be laid off, and profit to be earned during reinstatement will be lost (Wildman, Garvey, 2008, Wright & McNamara, 2000). This loss of profit and the cost of keeping employees while reinstatement takes place can be avoided through interruption insurance which ensures that the losses during the reinstatement periods are recovered in addition to reinstatement cost (Boland et al., 2004). The basic purpose of business interruption, according to Ransom (2003), is to reimburse those parts of ‘gross profit’ which are lost as a result of the inability of the business to operate after a fire or other insured event occurred. Previously, insurers were reluctant to offer business interruption insurances due to the concerns that during the periods of trading difficulties, there would be a temptation on the part of the insured to delay repairs and make claim from any business interruption insurance (Wildman et al., 2000). Another factor was that the ideas on how to arrange the cover and quantify the claim had not been fully developed. This was because accountancy at that time was still at its infancy, and many businesses were owned and operated by private individuals that made it difficult to separate the owner’s private money and income from those businesses (Wildman et al, 2000). Thus, whenever SMEs’ businesses experienced shutdown occasioned by fire or other insurable events, the employees of such SMEs are laid off until premises are rebuilt and re-equipped. The continued shutdown of business activities of the SMEs has adverse effect on economic growth. Many of the past studies carried out on SMEs have been limited to physical risk mitigation methods (Adeyele & Maiturare, 2012; Berger & Udell, 2001, Laforet & Tann, 2006; Reynolds & Lancaster, 2006, Verbano & Venturini 2013). Akinola (2014) as well as Reynolds and Lancaster (2006) examined how SMEs can be protected through physical risk control in order to prevent the occurrence of business losses but do not extend to how business’ property and pecuniary can be protected. In order to reduce economy waste, this study examines the extent to which business interruption policy can be used to protect earning capacity of the business. The specific objectives are to: (i) examine how means of conveying raw materials from their sources to SMEs’ business locations relate to loss exposures, and (ii) determine the relationship between the levels of responsibility assumed by SMEs’ owners exposed their business to various risks. The outcome of the study will serve as impetus to development and viability of business interruption underwriting for the selected SMEs in the Niger Delta Region (NDR) and in Nigeria at large. The services of actuaries alongside accountants are frequently sought by insurance companies to ascertain the extent of liabilities. The outcome of this study will assist the parties’ concerned – insurance companies and the SMEs’ owners - to undertake effective business underwritings. It will also be of interest to entrepreneurs, business owners, government and the policy makers in Nigeria. II. Literature Review A. Theoretical Framework Risk mitigationRisk mitigation is defined as measures (such as risk avoidance, prevention, or retention) put in place to protect the business’ properties against losses. Over a period of time (which may be years instead of months), a formalized risk management allows smooth running of SMEs’ businesses through appropriate risks assessment for improved business performance (Peck, Hill, Eaglestone, & McAulife, 2000). This usually begins with identification and assessment of various risk exposures in the light of their significance to organisation. Only a formalized risk and control system can lead to survival and sustained success of business enterprises (Waring & Glendon, 1998). For proper assessment of risk impact on business activities to take place, consideration of the prevailing risk control and measures that reduce the probability of risk occurring and its severity must be identified (Adeyele & Maiturare, 2012; Bamford & Bruton, 2006). On the other hand, risk mitigation is a one-off measure whereby the organisation has defined persons responsible for reducing the severity of loss whenever risk takes place (Huber & Imfeld, 2015). This suggests that risk control measures may differ in timing and nature. For the timing, measures can be applied to operate; before the event (BTE) - to reduce the probability of its occurrence, e.g. protective clothing, security guarding, good housekeeping; during the event (DTE) - to reduce the severity, e.g. extinguishers, sprinklers, boilers, standby power supply to key equipment or computers; and after the event (ATE) - to reduce the severity and further consequential impacts, e.g. contingency plans and computer disaster recovery centres (Atkins & Bates, 2007). Nature in contrast to timing, measures may either be ‘hard’ or ‘soft.’ The hard (physical) measures are employed to alter the risk by physical means, e.g. locks and bolts, fire escapes, safety goggles while the soft (organizational) measures are intended to ensure that people act in the appropriate way to reduce the risk, e.g. safety committees, ‘permits to work’, security patrols, no smoking rules (Atkins & Bates, 2007; Parsons, 2004). If all of these measures are put in place to protect SMEs businesses by their owners, insurance can be motivated to underwrite property and pecuniary risk exposures for such businesses. Development of Property and Pecuniary Insurances - Property insurance started in the UK in about 1700 when the first insurance companies were founded (Wildman et al., 2000). Companies started by issuing houses for fire in major cities with reasonable water supplies. After a period of time, companies gradually expanded their portfolios to insure houses outside the main cities and also shops and manufacturing premises, provided there was a nearby water supply (Wildman et al., 2000). Because some insurance companies failed, it became apparent that caution was essential when new risks were proposed for insurance and when demands were made for perils other than fire to be insured (Wildman et al., 2000). In other words, insurers quickly realised that they need to see for themselves how premises were used. They developed their own ideas on what was safe and acceptable for insurance. This process led to the development of property and pecuniary insurance for all forms of businesses. Pecuniary insurances cover various types of financial loss and can be contrasted with property (or material damage) insurances which cover some form of tangible property, such as building or physical damage by fire to the insured’s property. For business interruption insurance to protect any business, there must be in place material damage warranty policies which usually contain a number of warranties and conditions precedent to liability of the insurers for any loss. Warranty is basically a promise made by the insured, relating to facts or performance concerning the risk or that a state of facts existed or do not exist regarding the past or present as the case may be (Atkins & Bates, 2007). The necessity which would otherwise arise for the insurers of the business interruption loss to place similar warranties and conditions on their policies, thus making these lengthy, is avoided by the use of this provision (Isimoya, 2000). It also relieves them of the need to ascertain whether all such stipulations have been complied with. Furthermore, the possibility of a fire being deliberately caused by other dishonest circumstances must not be overlooked. The insurers who are responsible for providing an indemnity for the material damage are in better position to investigate any suspicious cases and so the insurers of the business interruption loss leaves that aspect to the material warranty insurers. If the claim under the fire insurance is not paid because it is fraudulent or because of a breach of warranty or for any other reason, there cannot be valid claim under the BI insurance. However, circumstances sometimes arise whereby liability is not admitted by the material damage insurers but nevertheless an ex gratia payment is made by BI insurers to the insured. In such cases the exact working of the material damage provision in the business interruption insurance according to Wildman et al., (2000), may be of considerable importance; and it states thus: provided that the time of the happening of the loss, destruction or damage, there shall be in force an insurance covering the interest of the insured in the property at the premises against such loss, destruction or damage and that payment shall have been made or liability admitted thereof. When property is destroyed or damaged by, say, fire, the insured is indemnified under their property insurance cover (for example, their fire and special perils policy). If they have adequate insurance, this will enable them to restore the buildings and contents to their pre-fire condition. If, however, the property was used by the insured for business purposes, they have also lost their productive capacity or future earnings power. Their normal business activities, whether as a manufacturer or a trader, may cease or reduce, depending on the extent and form of the damage. They have suffered a loss as a result of the fire which cannot be assessed or quantified until some uncertain future date, when they regain their earning power as a result of the reinstatement of their property or by some other means (Isimoya, 2000). It is an intangible future loss which is referred to as ‘time loss’, consequential loss’ or ‘loss of profit’ and which is the main subject of business interruption insurance (Atkin & Bates, 2007). Material Damage warranty and Business InterruptionIn the face of uncertainty, SMEs’ owners need to identify various risks such as fire, theft loss of profit that may affect their businesses through appropriate risk mitigation (Garvey, 2001). The individual business enterprise stands to be affected as a result of damage caused by fire or a kindred peril, its cash flow interrupted and part of its future earnings lost (Cloughton, 1991). Insurance is therefore necessary to afford protection against the loss of future earnings: and in the event of a claim a method of measuring that loss of future earnings must be applied. Cloughton (1991) revealed that the loss of turnover and material damage proviso are as follows: (a) Principle of loss of turnover In the UK, the basis of most of the business interruption insurance transaction is determined on the premise that reduction in turnover after a fire incident is a reliable guide to, and a suitable index for measuring the proportionate effect of the fire upon the earnings of a business. The actual loss can be ascertained by applying to this reduction the ratio which standing charges and net profit together normally bear to turnover. (b) Material Damage Proviso – general principle: The primary object of this proviso is to ensure that the insured will be kept in financial position to make good any damage to their own property – building or contents (Boland et al, 2000). Otherwise the reinstatement of a business might be delayed or be impossible and in that event part of the business interruption loss would not be proximately caused by the damage but by the insured’s lack of financial means to reinstate the business. The material damage proviso does not stipulate that the material damage cover is sufficient to restore the destroyed or damaged property, nor that the money is used for restoration if the claim is not settled on a reinstatement basis. Nevertheless, the requirement that the insured must minimize the business interruption loss should ensure that material damage claims monies are properly used. B. Conceptual Framework of the Study Following the above reviewed literatures, the conceptual framework for this study is designed around risk management process and business interruption insurance. Figure 2.1 and Figure 2.2 displayed the schematic requirements for business interruption to take place. Source: Authors’ Framework, 2016. Figure 2.1 shows the basic requirement for business interruption insurance detailed below: undertakings. The few of them that took insurance policy stopped at assets and contents protection – material warranty insurance. This also partly explains why many of the SMEs examined in this study have incurred huge losses caused by fire, theft and property damage in the last five years. It was also noted that the mitigation method (self insurance) employed by SMEs’ operators exposed their businesses to more threats rather than reducing them. However, SMEs’ owners can reduce part of their exposures to risks by making sure that their goods are carried on insured vehicles/vans. They can also make the SMEs’ suppliers to be responsible for safe delivery of all materials purchased from them. Otherwise, the continued ignorance of SMEs’ owners on how insurance companies can assist them to grow their businesses through business interruption insurance will always lead to early shutdown of SMEs’ businesses whenever insurable perils operate and no other formal means to recoup the losses. Thus, it becomes imperative therefore for them to consider business interruption insurance as a vital tool to recoup loss of future profits whenever there is business failure through fire incident or any of the insured perils. REFERENCES Adeyele, J.S. & Maiturare, M.N. (2012). Repositioning the Nigerian insurance industry for sustainable development. European Journal of Business and Management, 4(5), 22-30. Adeyele, J.S. & Maiturare, M.N. (2012). 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Journal of Technology Management and Innovation, 8(3), 186-197 Waring, A. & Glendon, A.I. (1998) Managing risk: Critical issues for survival and success into the 21st century. London:International Thomson Business. Wildman, P., Wright, J.D., McNamara, M. (2000). Principles of property and pecuniary insurances. London: The Chartered Insurance Institute. APENDIX Table 2b: Symmetric Measures for SMEs’ point of responsibility in respect of goods supplied to customers, business risk exposures and Insurance arrangement to mitigate risk exposure SMEs' point of responsibility in respect of goods supplied to customers Monte Carlo Sig. 95% Confidence Interval Valu e Asymp . Std. Errorb Appr ox. Tc Appr ox. Sig. Sig. Lowe r Boun d Upper Boun d At point of sale Nominal by Nominal Phi .527 .639 .627a .579 .675 Cramer's V .527 .639 .627a .579 .675 Ordinal by Ordinal Gamma .471 .144 .496 .620 .622a .574 .670 N of Valid Cases 158 At point where goods are loaded from suppliers’ warehousi ng Nominal by Nominal Phi .578 .618 .640a .592 .688 Cramer' s V .578 .618 .640a .592 .688 Ordinal by Ordinal Gamma .512 .186 1.615 .106 .129a .095 .162 N of Valid Cases 84 At point where the goods loaded from SMEs' warehouse are delivered to customer's Location Nominal by Nominal Phi .833 .000 .000a .000 .008 Cramer' s V .833 .000 .000a .000 .008 Ordinal by Ordinal Gamma .794 .115 3.248 .001 .005a .000 .012 N of Valid Cases 144 Source: Authors’ Computation, 2016. Table 3b: Symmetric Measures for SMEs' major sources of raw material, means of conveying goods purchased to business location and Loss/damage to purchased goods Means of conveying goods purchased to business location Monte Carlo Sig. 95% Confidence Interval Value Asym p. Std. Errorb Appro x. Tc Approx . Sig. Sig. Lower Bound Upper Bound Owned van / Vehicle Nominal by Nominal Phi 0.564 0.053 .049a 0.027 0.07 Cramer' s V 0.564 0.053 .049a 0.027 0.07 Ordinal by Ordinal Gamma 0.563 0.117 1.39 0.164 .167a 0.13 0.204 N of Valid Cases 217 Hired van / Vehicle Nominal by Nominal Phi 0.621 0.05 .046a 0.025 0.067 Cramer' s V 0.621 0.05 .046a 0.025 0.067 Ordinal by Ordinal Gamma 0.852 0.134 2.497 0.013 .015a 0.003 0.028 N of Valid Cases 122 Relation/ Friend's van/vehi cle Nominal by Nominal Phi 0.572 0.477 .496a 0.446 0.546 Cramer's V 0.572 0.477 .496a 0.446 0.546 Ordinal by Ordinal Gamma 0.511 0.234 0.473 0.636 .666a 0.619 0.713 N of Valid Cases 50 Source: Authors’ Computation, 2016.