by Chris Smith
April 27, 2012

Restructure risk management in your construction company to prepare for increased exposures and maximize results.

Throughout my 22 years in construction insurance, I have worked with many different construction companies operating in different markets—from large general contractors to small specialty firms. And I have found that most of them mishandle risk management.

Historically, general contractors have been able to mask this problem by purchasing broad insurance policies, transferring their risks to subcontractors through indemnification provisions and hold-harmless agreements or buying additional insurance.

Unfortunately, these methods no longer work, and general contractors will continue facing more risk exposures. States have started limiting broad form indemnification provisions in contracts, and recently, laws have been established in states such as Texas and Colorado that limit the amount of additional insurance as well. This seems to be a trend. California will also enact similar insurance limitations in 2013. 

In states where these laws have been passed, general contractors must address the potential for litigation of every claim to prove liability. In addition to legal changes, the insurance industry is on the cusp of a hard market. Many general contractors have already seen rate increases. General contractors with quality insurance and safety and claims controls will be the ones to maintain steady rates in the coming years.

These challenges point to an increasing need for general contractors to efficiently and carefully handle insurance and risk management. 

Construction Risk Financing Techniques

Contractors must take advantage of insurance products including risk financing techniques such as Contractor Controlled Insurance Programs (CCIPs). CCIPs usually have large deductibles or other self-insurance requirements, and the general contractor usually purchases this insurance, which includes coverage for all subcontractors on a project site. 

This type of insurance has been around for more than 20 years, but only recently have general contractors been willing to take on this type of coverage. This cost-effective solution ensures that all project parties have uniform coverage while eliminating cross-claims and controversial litigation.

Subcontractor Default Insurance (SDI) has also become more widely used. In today’s economic environment, contractors need subcontractor prequalifications to protect their companies’ balance sheets. A single subcontractor default can have a large impact on a general contractor. 

With SDI, general contractors can avoid surety companies and receive indemnification as long as the default falls under the policy coverage. Unlike the surety relationship that often involves a long wait for reimbursement, the subcontractor default policy allows contractors to control and manage the default situation, which can speed up the recovery of funds. General contractors who use this insurance have had success.

SDI and CCIP do require a time and energy investment from the general contractor. It takes time to customize the program and monitor the results. And most general contractors do not have the organizational structure to do this work.

A Simple Change with a Large Impact

To effectively manage risks, general contractors need to make a cultural change that shifts the risk management function to the operations department. 

Most construction company organizational charts treat risk management as a support function and place the responsibility on the chief financial officer or chief legal counsel. Many owners think the position should fall under the finance department or under legal supervision since insurance deals with money and claims may be involved. 

But a CFO or legal counsel cannot provide as much oversight, input and evaluation as necessary during the construction process—which limits their contribution to problem-solving risks and maximizing the company’s results.

Construction risk management involves more than enhancing safety. It should cover all aspects of a company’s business, from initial contract documents, to operations, to post-construction activities.

Also, if a construction company has a dedicated risk manager, it can be difficult to enforce the risk management decisions if this person does not work in operations. Imagine a situation in which the risk manager thinks the company should adopt a 6-foot fall rule to reduce the company’s claims and lower their insurance premiums. 

The operations team may not want to adopt this change since it will require pushing their subcontractors to comply with this rule and potentially increase costs. The operations team will be most concerned with winning the job and building the project, not reducing the risks. They do not want interference from insurance.

Unfortunately, this type of conflict happens all the time to the company’s detriment. It leads to poor communication and difficulty in efficiently managing risks.  

Shifting accountability to the operations where most risks occur will help the operations department gain a greater understanding of the risks and better control these issues. When this shift happens, it becomes much easier to implement advanced risk financing programs like CCIP and SDI.  

A Risk management  success story

Turner Construction Company restructured their risk management team in the late 1990s and has had positive results. In the 1990s, Turner was a $4 to $5 billion company with 3,000 employees. For almost 100 years, they followed the model that places the risk management responsibility on the finance department, and for almost 100 years, their risk manager had little influence on the company’s operations outside of buying insurance policies. 

Even though Turner was a large company and could work with any insurance carrier, they continued to see rising insurance costs and battled ever-increasing unreimbursed litigation expenses. They realized they needed to change how they handled risk management.

In 2000, they hired a claims manager and an insurance manager and placed them in the operations department. Working under the executive vice president of operations, they built a risk management group that helped the company implement a CCIP and establish a subcontractor default program. 

Turner’s risk managers also built a synergy among all of Turner’s operations. Turner’s risk management department now has almost 30 full-time employees supporting a construction volume of nearly $10 billion, and they have the largest CCIP in the industry. 

A GC of any size can make this change. In fact, smaller firms may have an easier time making the transition—a company-wide culture change can be implemented faster with fewer employees and less geographic separation. 

An abrupt or radical change in a risk management strategy can bring about new ideas and provide a path for future growth and prosperity. Construction companies that implement a revolution in risk management techniques and organizational changes will experience amazing results. 

Construction Business Owner, May 2012