Editorial

What You See is not What You Get

Dental practices’ most valuable asset remains uninsurable.

It happens. Devastating events damage or destroy dental practice assets, both tangible and intangible. Available insurances currently cover only physical damage to tangible structures, equipment and items you can see and touch, and limited intangibles only when concurrent with such physical damage. This framework leaves coverage gaps for intangible losses, such as lost income unrelated to physical damage and, more importantly, for damage to a practice’s most valuable asset, intangible goodwill.

In order to protect dentists’ risk and return on their financial investment in their practices, insurers need to develop intangible business interruption insurance that compensates dentists for loss of not only what you see but, also, all the intangible losses dental practices incur in devastating events.

Devastating Events and Current Coverages The events that damage practice assets vary from natural disasters and cyberattacks to, most recently, COVID-related government-mandated restrictions. We can classify these events into three categories with respect to the type of damage incurred: solely physical damage; solely intangible damage; and physical damage with intangible asset losses, including practice goodwill.

In the event of solely physical damage, with no concurrent intangible loss, commercial property insurance adequately covers the repair or replacement of the tangible building structure, equipment and supplies.

Recent COVID-related practice restriction cases highlight one key aspect of current inadequate coverage for solely intangible asset damage. During the early pandemic, dentists filed a torrent of business interruption insurance claims for the intangibles, lost business income and extra expenses. Dentists argued that mandated COVID practice restrictions or closures of their premises, in whole or in part, constituted direct physical loss under their policies in order to trigger intangible coverage. The insurers typically denied these claims, countering that the policy language specifically required a trigger of “physical loss or damage” or permanent alteration to the premises in order to engage coverage. These denials led to extensive litigation and the first case to make its way to a U.S. Court of Appeals, which ruled in favor of the insurer. [1] The court concluded that the business interruption policy never intended, and the insured did not purchase, coverage unrelated to actual physical loss. [2] This result signals the need for insurance carriers to develop a coverage for solely intangible losses that insurers can successfully fund and dentists can afford.

Hurricanes, floods, fires and some cyberattacks cause easily proven physical damage, with associated intangible loss. Commercial property insurance adequately covers the tangible damages. As long as the insured proves actual physical damage, business interruption insurance covers the intangible lost income and extra expenses, such as continuing rent, mortgage payments, utilities, payroll, taxes and debt repayment for a limited period, depending on the specific policy and exclusions. However, no coverage currently compensates dentists for lost practice goodwill.

What You Cannot See Practice goodwill represents the level of trust and loyalty in the existing relationships of owner dentists with patients, staff and the community. It includes the intangibles that enhance future earnings, such as reputation, brand and dentists’ business methodologies related to patient records, recall systems and non-compete agreements with key employees. Financially, it represents the likelihood patients will stay with a practice through ownership transitions, ensuring the continued revenue stream and cash flow of a going concern. Analytics place the average value of a practice’s goodwill at 60% to 80% of the total appraised practice value, usually the most valuable practice asset. [3]

What You Get When an event forces a practice to cease operations for an extended period or mass evacuations temporarily or permanently displace a significant percentage of a patient base, it reduces the likelihood that such a practice’s patients will return. In 2017, authorities evacuated more than six million residents in response to Hurricane Irma. [4] The reduced cash flow impairs practice owners’ ability to service their debt and drastically reduces the practice value.

Consider the risk of investment of a dentist who purchases an existing practice for $500,000. The intangibles, including goodwill, will typically range in value from $300,000 to $400,000. In the event of a natural disaster and a complete destruction of the practice, such as seen in severe hurricanes, business interruption insurance would only cover the loss of the $100,000 to $200,000 of tangible assets and limited lost income and expenses. Where the disaster prevents the dentist’s return to the same location, displaces current patients or significantly alters the demographics in the area, it could irreparably damage the practice goodwill and leave the devastated dentist with a $300,000 to $400,000 negative return on investment. If the dentist had successfully increased the goodwill value after the purchase, and prior to the damage, it would magnify the dentist’s loss. Assuming the dentist financed $400,000 (or 80%) of the original practice purchase, the dentist then must struggle to repay the balance of the debt to the lender without the goodwill generated cash flow and risk default.

The Goodwill Coverage Gap Challenge Practice goodwill remains uninsured, primarily because indemnitybased insurances, such as current business interruption policies, lack reliable methodologies to classify and evaluate the value of intangible damages. [5] Other barriers to the development of intangible business interruption coverage include the insurance industry’s financial capacity to provide coverage to the limits required, especially for catastrophic losses, and dentists’ ability to afford, or willingness to pay, the high premiums such coverage could command.

Parametric insurance may offer a reasonable solution to the intangible insurance dilemma. These policies do not require precise damage calculation and do not attempt to indemnify the insured for actual losses. Rather, the insurer bases payout on a pre-agreed trigger and pre-defined schedule.

Parametric coverage uses algorithms to predict the probability of an event, such as a natural disaster occurring, and offers a guaranteed payout after a qualifying event. For example, a policy could agree to pay a stated percentage (50% to 100%) of a predefined limit for losses from a designated-strength storm, flood, earthquake, etc., within a designated geographic area. [6] In addition, the parametric coverage would not replace but only fill gaps and supplement current traditional business interruption insurance. This more flexible structure enables more predictable payout amounts, which will allow both insurers and insured dentists to better manage their costs.

The current U.S. trend toward larger, consolidated, multiestablishment dental practices [7] accentuates dentists’ need for affordable intangible business interruption insurance. As practice size and number of dentists per practice increase, this consolidation will continue to raise the percentage goodwill value represents of total practice values. Inadequate intangible asset insurance coverage for an increasing goodwill asset widens the coverage gap for devastating event damages. It increases the risk of defaults and bankruptcies on personally guaranteed practice acquisition loans and significantly depletes practice owners’ return on investment. As entrepreneurs, dentists risk their personal and professional financial futures on their practice investment. Insurance carriers must offer affordable coverage of dental practices’ most valuable asset in order to protect this investment.

REFERENCES

1. Godes S. State of Law for Business Interruption Insurance Coverage for COVID-19 Claims.https://btlaw.com/insights/blogs/policyholder-protection/2021/state-of-the-law-forbusiness-interruption-insurance-coverage-for-covid19-claims. May 14, 2021.

2. 8th Circuit Court of Appeals decision, Oral Surgeons, P.C. v. Cincinnati Insurance Company. US District Court Appellate Case 20-3211, Filed 7/2/21.

3. Brown F. The Value of Goodwill. https://www.dentaleconomics.com/practice/article/16391649/the-value-of-goodwill. Accessed 8/22/21.

4. Solana K. Florida dentists begin cleanup after Hurricane Irma. ADA News, September 18, 2017, p. 26.

5. Schmalbach M. Parametric insurance the key to insuring intangible assets: RYSKEX. https://www.captiveinternational.com/news/parametric-insurance-the-key-to-insuringintangible-assets-ryskex-3367. Sept. 3, 2020.

6. Brettler D, Gosnear T. Parametric Insurance Fills Gaps Where Traditional Insurance Fails Short. https://www.insurancejournal.com/news/international/2020/01/09/553850.htm. Accessed 7/24/21.

7. Wall T, Guay A. Very Large Dental Practices Seeing Significant Growth in Market Share. http://www.ada.org/~/media/ADA/Science%20and%20Research/HPI/Files/HPI- Brief_0815_2.ashx August 2015.

CALL FOR PAPERS

The New York State Dental Journal is planning to devote its January 2022 issue to the topic “Increasing Workforce Diversity in Dentistry,” an examination of the impact improved diversity among practitioners may have on reducing oral health disparities across population groups. We are looking in particular for papers that explore improvements in recruiting methods to address opportunity gaps, strategic outreach to underrepresented groups and the legal aspects of dental school admission practices.

Interested contributors are asked to submit their papers electronically to the managing editor by Nov. 1, 2021. Address papers and queries to Mary Stoll, mstoll@nysdental.org; (800) 255-2100.