Editor's Note: This is part one of a two-part article. To read part two, click here .
The construction industry has come to recognize the relationship between managing risk and return on investment.
Now considered a serious profit initiative, risk management in today's insurance market requires beyond-the-edge thinking if a contractor is to maintain a competitive advantage. The risk management technologies outlined here offer contractors the means to generate additional earnings while leveling out losses.
It is apparent that lean and fit organizations represent a platform for long-term survival. Yet, many contractors have also recognized the importance of imagination, vision, and competitive information if they are to succeed in a competitive market. In this respect, risk management has emerged as an additional source of creativity and vision that is enhancing the competitive edge of many contractors despite the softness of the construction insurance market. At last, managing risk has been transformed from a once-a-year insurance bidding frenzy with the local agent into a serious profit initiative, having the ability to boost returns, create equity, reduce costs and permanently change the way construction firms are managed.
This shift of recognizing and managing risk has occurred due to the construction industry's enlightened perspective on "risk" and its integration with the overall cost to fund losses. This cost is no longer viewed as an expense item but as an opportunity to make a reasonable return on risk dollars that are currently being consumed to protect and preserve the assets of the construction firm.
The risk management technology available today has long passed the traditional insurance policy buyer in favor of sophisticated construction firms that are astute enough to put each and every risk dollar to work for the company, generating additional earnings while leveling out the losses on bad projects. The following represents a few risk management technologies that need to be reinforced in a contractor's business.
Allocating risk on construction projects continues to be an often-overlooked area in analyzing risk profiles for contractors. The effective use of hold harmless and indemnification agreements can reduce, and oftentimes manage, specific types of losses (particularly "action-over" lawsuits) that would have been otherwise absorbed into the contractor's operations or insurance program. The following list provides some ideas for capitalizing on this technology:
- A standard subcontract document and purchase order should be reviewed for enforceability and insurability; this document should also be updated, when necessary, to incorporate recent case law on indemnification wording. Traditionally, indemnification agreements have been classified into three types: Broad Form, Intermediate Form and Limited Form. Whatever form is chosen, this agreement should serve as the basis for distributing risk within projects.
- This standard subcontract/purchase order should contain specific language with respect to types of policies/coverages required, minimum limits of liability and endorsements that protect the interest of the construction entity seeking indemnity. For example:
- Additional Insured -adding the name of the general contractor to a subcontractor's general liability policy as an additional insured. Due to the new forms from ISO, this is becoming a more difficult issue with regard to completed operations, residential restrictions and indemnity agreements.
- Insurance Considered Primary -the liability program of the subcontractor or sub-subcontractor shall be considered primary in the event of a loss.
- Cancellation Notice -usually as much as 60 days for cancellation and/or non-renewal is desired.
- Waiver of Subrogation -to avoid subrogation proceedings on losses by the subcontractor's insurer. It must be noted that these recommendations apply to all contractors.
- Route all contracts, purchase orders and agreements that require certificates of insurance to a centralized department where an insurance coordinator, risk manager or contract coordinator oversees the documents.
- Use form letters when requesting the standard certificate of insurance to be completed.
- Suspend the request and follow-up within thirty to sixty days from the date of request.
- Develop a database of third-party certificates, based upon renewal dates for easier retrieval and follow-up each month.
Hold harmless clauses are only as good as the indemnitor's ability to respond to assumed liabilities, and waivers of subrogation apply only to insurance that is in force. Certificates of insurance are an important control system and should be monitored as such. Remember, contractual transfer is nothing more than an additional risk-financing tool. The certificate represents the method by which such losses will get paid.
The insurance marketplace has undergone some improvements during the past year. There are some classifications of work that continue to be difficult, such as residential construction. However, it's important to realize that most contractors are enjoying the benefits of a more competitive market and are realizing rate reductions over last year by as much as 10 percent. Remaining a competitive, yet profitable, force in the market requires contractors to focus on true cost and how it might compare in best-of-class benchmarking from an insurance perspective.
It's important to match the risk-financing plan with your company's goals, objectives, financial capabilities and cash flow needs. Not all financing plans are created equal; each has its own uniqueness in satisfying a contractor's risk management goals.