by Jeff Cavignac
November 2, 2009

There is no line item on a construction company's income statement titled "Cost of Risk," but this is typically one of the industry's largest and most volatile expense items.

Some construction companies pay 5 percent or more of their gross income for risk related costs. In an industry with tight profit margins, effectively managing risk can sometimes make the difference between making a profit or not, and in some cases, the survival of the business.

"Cost of risk" is typically defined to include:

Insurance premiums -These include but are not limited to general liability, auto, property, excess, worker's compensation, professional liability, pollution liability, employment practices liability, inland marine, surety and employee benefits.

Time spent analyzing and managing risk -This includes the time invested to identify potential losses and their causes and deciding on a strategy to manage those losses. It also includes time spent managing your safety program, human resources and claims.

Time spent dealing with losses -This could involve efforts to work with employees and designated clinics for a worker's compensation claim, dealing with an insurance adjuster on a property claim or participating in your defense of a lawsuit against your company.

Retained losses -Losses are either retained on purpose (deductibles, self insured retentions or self insurance) or by accident. Effective risk management should help avoid retaining a loss accidentally.

What is Risk Management?

Traditional risk management focuses on what is called "hazard risk." Hazard risk deals with accidental or fortuitous losses. These risks involve the potential for loss without any corresponding possibility of gain. "Business risk," on the other hand, deals with the risk of conducting business. It includes the possibility of loss, no loss or gain. Investment in a new piece of machinery or acquiring another entity are examples of business risk. Collectively, hazard risk and business risk make up what is known as "enterprise risk management."

Most construction companies focus on hazard risk or traditional risk management. In its simplest form, risk management involves the identification, evaluation and management of a company's exposures to loss. A "loss exposure" is defined as any condition that could result in financial loss to an organization. In other words, risk management attempts to mitigate the occurrence of losses while initiating advance planning to assure that adequate funds will be available to cover those losses that occur. The primary function of risk management is to protect the assets and financial viability of the company, and secondarily to lower the total cost of risk.

Whether or not someone has the official title of "Risk Manager" in your company doesn't matter; someone should be managing your risk. If you don't know who that is, your risk may not be managed very well. The first step in an effective risk management program is to designate the individual or individuals who will be responsible for this function.

The Risk Management Process

To effectively manage risk, it helps to develop a systematic approach. There are a number of ways to do this, but all approaches basically involve the following steps:

  • Risk analysis
  • Risk control
  • Risk transfer
  • Risk review
  • Risk refinement

Risk Analysis

Risk analysis is the first and perhaps the most important step in the risk management process. The purpose is to identify "exposures to loss"-things that, if they go wrong, could cost the company money. There are only four types of loss exposures:

  • Property
  • Loss of income
  • Personnel
  • Third party liability

The correct way to identify and analyze exposures is to do so systematically, using an exposure analysis program or checklist. In addition to the checklist, financial statements, flow charts, contracts, marketing materials, etc., can be helpful. Once exposures have been identified, they need to be analyzed. Some exposures are minimal and can be retained. Others lend themselves to being controlled, and still others will need to be transferred, avoided or financed. The key is being proactive in this process. It is better to understand your risks and make conscious decisions about how to handle them than to find out at the time of a loss that you are uncovered and unprepared.

Risk Control

Risk control involves any strategies or techniques you can implement to lower the frequency or severity of a loss exposure. Risk control includes safety, claims management and human resources.

Safety is critically important to a construction company. Unsafe companies won't survive long. A poor safety record and loss history can drive a company's insurance costs so high that they simply can't compete. Every construction company should have someone responsible for safety. Like a lot of things, most safety issues are fundamental and straightforward. Is your Injury and Illness Prevention Program valid and compliant with your state's Code of Regulations? Are your supervisors familiar with your safety program, and are they able to teach and monitor your program? Are your safety meetings effective?

You and your safety officer should do a self analysis of your company's safety culture and determine where you need to improve. Working with your broker and insurance company, develop a schedule of risk control services, which will help you accomplish your objectives.

Claim management is equally as important. Even the best firms will have accidents. How you manage an accident, however, can have a material effect on the ultimate cost. Have you appointed a risk manager or claims supervisor in your company who is responsible for coordinating all claims and accidents? Have the appropriate individuals in your company (job superintendants, project managers, etc.) been educated in post-accident response training? Have you designated a medical provider network for worker's compensation claims? Have you developed an Early Return to Work program? Have you established a relationship with your broker's claim manager as well as your insurance company's claim adjusters?

Human resources (HR) are also a major area of concern for most construction companies. The challenge of making certain your HR practices comply with the myriad of laws and regulations imposed by the numerous organizations that deal with these issues is mind-numbingly difficult.

Do you have a full time HR staffer,