Jeff Cavignac, CPCU, ARM, RPLU, CRIS, is president and principal of Cavignac & Associates, a commercial insurance brokerage firm providing a broad range of insurance and expertise to design and construction firms, law firms, real estate related entities, manufacturing companies and the general business community.
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 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:
- Loss of income
- 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 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, or have you appointed someone in your company to handle this function? Has your employee handbook been reviewed for compliance? Have your supervisors been through Sexual Harassment Prevention Training (AB 1825)? This is required for all employers with fifty or more employees. Are you confident that your hiring, firing and discipline policies and procedures are legal and effective?
Once again, the key is to identify where you need to improve and then develop a schedule to accomplish your objectives. There are numerous tools available to help a company improve its HR practices (HR That Works, a web-based resource, is one of the best). The key is identifying where you need to improve.
Once you have identified and analyzed your risk and developed risk control techniques to lower the frequency and severity of your loss exposures, it is time to consider "risk transfer." Risk transfer includes retention, contractual risk transfer and insurance risk transfer.
Retention can be purposeful or accidental. Ideally, it is purposeful. Some exposures are low severity and should be retained and managed. Other exposures are low frequency and high severity and should be transferred (usually insured). Finally, some are high frequency and high severity and should be avoided. Regardless, you should decide how much risk you want to retain and tailor your insurance program accordingly with appropriate deductibles and self insured retentions.
Contractual risk transfer is a significant issue for construction companies. Whether you act as a general contractor or a subcontractor, risk is transferred every time you sign a contract. Generally, risk is transferred through an indemnity agreement; however, other aspects of the contract are important as well.
Do you understand the risk you are being asked to assume? Do you know if it is insurable? Do you know if your insurance program meets the insurance requirements of the agreement? Are your subcontract insurance requirements adequate and reasonable? Do you have an attorney and insurance broker you can use when you have questions or issues?
Insurance risk transfer is the most common form of risk transfer. Basically, you are agreeing to transfer the potential consequences of certain specified loss exposures to an insurance company for an agreed-upon cost or premium. Insurance is often the most expensive component of the cost of risk, but there is a reason it is the third step in the risk management process. It is only after you have identified and analyzed your exposures and implemented effective risk control techniques that you can determine what you want to insure.
If you have done the first two steps correctly, you should be in a position to approach the insurance marketplace with a well thought-out submission that highlights the attributes of your company's risk management efforts, why you are a better-than-average risk from the underwriter's standpoint and why you deserve a favorable rate.
Have you aligned yourself with the right insurance broker? One who understands construction and has the staff and relationships to effectively market your program? Are you with the right insurance company? Have you given thought as to whether or not it makes sense to market your program?
Risk Review and Refinement
Risk management is a process that does not end with risk transfer. Exposures change and need to be effectively managed. Service issues for construction companies are significant. Providing and tracking Certificates of Insurance is a huge task.
Your designated risk manager needs to be kept in the loop on any changes that might affect the company's risk management program, and he/she needs to communicate this information, in a timely manner, to your insurance broker.
Cost of risk is a concept many construction firms have never thought about despite the fact that it is one of the largest expense items. An effective risk management process will provide a logical approach to managing the risks that a construction firm faces. The process should be simple and straightforward. The key is to have the support of the company principals and a qualified insurance professional who can quarterback the process.
Loss Exposure-Any condition that represents a possibility of loss, whether or not an actual loss occurs.
Risk Management-The practice of identifying and analyzing loss exposures while taking steps to minimize the financial impact of the risks they impose.
Risk Analysis-The process of identifying and analyzing exposures to loss
Risk Control-Strategies and techniques designed to reduce the frequency and severity of a loss exposure.
Construction Business Owner, November 2009