Steven D. Davis, CPCU, ARM, is senior vice president and director of Construction Risk Services with McGriff, Seibels & Williams. With more than 30 years of experience in negotiating, placing, servicing and developing programs for ENR Top 200 construction accounts, Davis is widely regarded as an industry expert. The author of AGC’s Risk Management, Insurance & Bonding for the Construction Industry, he specializes in alternative risk financing methods, such as captives, OCIPs and CCIPs. Davis also participates on the construction speaking circuit for organizations such as AGC, CFMA, AICPA and the International Risk Management Institute (IRMI) and serves on the national AGC Risk Management Committee and Surety Committee. For more information, visit www.mcgriff.com.
No construction firm is immune to employee dishonesty or crime losses. While crime exposures for some businesses can be measured and quantified by the amount of cash or other valuables on hand, employee fidelity claims in the construction industry and the losses arising out of such acts can be difficult to identify or quantify.
The challenging economic conditions over the past four years combined with the capabilities of the Internet have caused contractors to see an increase in employee theft and dishonesty claims. Studies by the industry identify employee theft as representing more than 20 percent of the crime losses, and in many cases, contractors maintain little or no insurance for these exposures and have not focused on this area of risk management. Mergers, acquisitions, downsizing and restructuring place internal pressure on the controls of any construction enterprise, and the industry as a whole has certainly undergone its share of changes in the past few years. This pressure creates the perfect conditions for acts of crime and dishonesty by employees and third parties.
Despite the difficult economic conditions, most construction firms, especially small to medium-size firms, don’t typically purchase fidelity or crime insurance at all. Studies show that only 23 percent of firms with less than 250 employees procure some type of crime insurance policy, and only 43 percent of larger firms do so.
The Association of Certified Fraud Examiners estimates that fraud costs U.S. businesses more than $650 billion annually. Elaborate procurement schemes, kickbacks, accounts payable and phantom suppliers are some examples of how employees can “rob a contractor blind.” It is important to keep in mind that embezzlement usually occurs over a long period of time, complicating the ability to define the exposure to a typical contractor. Here are some examples of crimes that have resulted in losses incurred over both short and long periods of time:
Example one—A contractor suffered more than $2 million in losses from wire theft committed by a group of employees who had oversight responsibilities for materials management. The copper wire was removed over an extended period of time from the contractor’s warehouse and taken to a “burn barn,” where the copper was harvested to be sold as scrap. This loss occurred over four years and was actually discovered by accident—by a third party. Between September 2008 and July 2011, copper prices increased almost fivefold, giving the incentive for foul play by these employees. The contractor lacked specific controls on warehouse materials management and failed to monitor the fluctuating values.
Example two—A contractor discovered that a project manager had established a ghost vendor for roofing materials to be procured for a project site. This claim ultimately cost the contractor more than $500,000. With a new project manager on an isolated project, corporate management controls were desperately needed, but in the hustle to win the bid and complete the work on time and on budget, those management controls were not put in place in a timely fashion. This scam took less than six months to complete, and the contractor and the authorities are still searching for the elusive project manager.
Both of these claim examples identify significant direct monetary loss. However, they do not take into account the indirect losses relating to the time of the contractor’s executive staff, the expenses associated with project delay or the damage to the contractor’s reputation if the loss involves a client. In most instances, the indirect costs associated with losses dwarf the actual claim dollars by a ratio of 3:1. So, for every dollar in direct loss cost, there are three dollars in expense related to investigating and managing the claim.
While contractors historically have not focused attention on crime insurance as a significant exposure to their operations, claim examples like the ones discussed have turned the attention of construction executives to make this area a larger part of their overall risk management and insurance programs.
THE INSURANCE POLICY
Most insurance companies have package policies that include the following coverages:
- Crime insurance
- Fiduciary liability
- Directors and officers liability insurance
- Employment practices liability insurance
- Kidnap/ransom and extortion insurance
- Outside directorship liability insurance
EMPLOYMENT PRACTICES LIABILITY (EPL)
Employment practices claims typically involve a variety of issues, such as sexual harassment, hostile work environment, age discrimination and wage and hour claims for nonexempt employees claiming lost compensation. Wage and hour claims are typically class-action suits and are extremely expensive. As a result, many insurance company underwriters are not including such claims in coverage forms. This has become a serious challenge for construction firms.
Chubb Insurance recently conducted a business study and survey asking business executives the following question: “Which one loss event covered by the survey would cause the most financial damage?”
Employment practices lawsuits ranked at the top, with 36 percent of respondents stating that such a claim would cause significant financial damage to their firm. The second loss type found in the rankings was employee theft. Again, these two claim areas for all businesses are increasing, but even more so for construction firms, as such exposures have often been either viewed as a cost of doing business or simply ignored.
Employment practices lawsuits are among the largest and most common risks faced by private companies in the U.S., and according to Chubb Insurance, more than one in five companies surveyed experienced an EPL charge or lawsuit in the past five years. With the median EPL jury award exceeding $300,000, contractors are expanding their thinking on employee orientation, training, job appraisals and record keeping.
Small contractors are less likely to purchase crime insurance or EPL liability insurance and often have fewer resources and processes to manage such exposures. They continue to be particularly vulnerable to both crime and employment practices claims as evidenced by the rate increases being sought by insurance companies underwriting crime and EPL insurance.
In comparison to general liability, automobile liability and worker’s compensation, crime and EPL insurance coverages are relatively inexpensive. However, due to the losses within the industry, premiums are increasing in the 5- to 10-percent range at renewals, depending on losses sustained by the insured.
A recent “mass-action” lawsuit related to a construction firm’s layoffs during the slower economic time reminds us to consider higher limits for EPL coverage and to focus risk management resources, with proper reviews by a labor attorney, on areas such as recruitment and hiring, background checks, job evaluations and appraisals, immigration considerations, periodic testing, layoffs and workplace harassment.
Chubb and other insurance companies have developed effective loss-prevention guidelines for EPL and related coverages, with practical recommendations on how to manage these exposures more effectively. With state and federal laws impacting employment both directly and indirectly, contractors and all businesses are challenged to maintain sufficient knowledge on the legal obligations imposed.
For a more detailed checklist on coverage and terms, please refer to the International Risk Management Institute’s website, at www.irmi.com.