Managing Risk – The Hidden Costs of Poor Risk Management Programs

Kristi Pronovost Merit Shop Spokesman Blog

By: Chris Scott, Business Development Associate, Arthur J. Gallagher & Co., and ABC Keystone Young Professionals Committee Member

The construction industry is full of risks and exposures that workers face on a daily basis. Effective Risk Management and Safety programs are integral in avoiding incidents and keeping workers safe on jobsites. Safety is the top priority in construction, and companies often pledge to take the necessary steps to send each employee home safe at the end of the day. Although these programs are implemented with the primary goal of avoiding accidents and injuries, an often overlooked benefit of strong Risk and Safety programs is the financial impact on the company.

The potential for financial losses exists in construction because it is such a hazardous industry with a high frequency of accidents. The constant exposure to incidents makes preventing, or at the very least controlling, losses when accidents occur all the more important. Injuries trigger the direct costs which include medical payments, repair costs, indemnity payments, etc. However, it is the indirect or hidden costs from a loss that often impact companies most. Costs that insurance does not cover, such as schedule delays, legal fees, training new employees, and more, can often cost about 4-20 times more than the direct costs of an accident. 65% of insurance costs are compiled from losses and loss expenses, so it is imperative to establish effective risk and safety processes to control those costs.

Accidents have the potential to cause a staggering financial impact that may be unrecognized by contractors. A useful way to quantify the impact that an accident has on a construction business is by understanding the amount of additional work to be completed to recover internal costs paid for accidents. According to the Pennsylvania Department of Labor & Industry, a contractor with $10,000 in annual accident costs would need to complete an additional $500,000 of work at a 2% profit margin just to recover the internal costs of the accident. As the accident costs continue to rise, the additional work revenue to recover those costs will proportionally rise as well.

Another major hidden cost comes from the impact that poor loss control programs can have on a contractor’s Experience Modification Rating (EMR). The EMR is a number that is based upon work classification, payroll, and losses that is used by insurance companies to gauge both past cost of injuries and future chances of risk. The industry average for an EMR is 1.0, which means contractors with an EMR higher than 1.0 are considered to have higher than average risk, which results in paying higher insurance premiums. For example, an EMR of 1.2 will result in 20% higher insurance premiums than the “average” (1.0) contractor. In addition to insurance premiums, the EMR will have an impact cost on bidding as well. For example, consider a contractor that is bidding on a $5 million project with $1.75 million in payroll with an average rate for Worker’s Compensation cost at $7.00. If that contractor had a 1.2 EMR, compared to a 0.7 EMR, the insurance cost on the bid would be about 30% greater solely because of the poor risk programs and higher EMR.

Risk Management and Safety programs are occasionally overlooked by contractors. While most of the business is focused on completing profitable work, it is important to develop processes that can help eliminate accidents and losses, and save money. Efficient operations and effective Risk programs will allow contractors to succeed in this demanding industry.