>> October 2008
>> Controlling Losses Is Critical for Construction Firm Growth
Current insurance market conditions are ripe for contractors with growth plans. In its first quarter 2008 survey, the Council of Insurance Agents and Brokers reported average commercial insurance rate decreases of 13.5 percent. MarketScout, which provides a monthly barometer of the industry, reported average composite property and casualty rate decreases of 10 percent in June for construction firms. This is good news for companies trying to grow, but not because they have extra cash on hand to hire more people or purchase new equipment. It’s good news because they can invest that extra cash in building and supporting safety and loss-prevention programs.
Companies often lose focus on loss control during soft market cycles because insurers hand out rate reductions more freely. But these markets operate cyclically; they will harden and rates will increase again. When the market hardens, disciplined underwriting will resurface, and companies that kept their losses flat or saw a slight increase will be dealt a severe blow at renewal time.
Hardening markets combined with losses and corporate growth can spell disaster for a construction company. Losses can affect a growing firm in many ways.
Loss Ratios and Expected Losses
Current and past losses affect future premiums. Underwriters calculate loss ratios by dividing a company’s losses by its premium. If a company paid $100,000 for insurance coverage, and had $45,000 in claims, its loss ratio would be 45 percent.
But when premiums decrease, this ratio goes up quickly if losses don’t follow suit. For example, after three years of 10 percent reductions on a $100,000 policy, a company would be paying $72,900—an overall reduction of more than 27 percent. But if its losses stayed constant at $45,000, it would have a 62 percent loss ratio. And if the company lost focus on its losses during those three years—which is easy to do when rates are declining—and losses rose to $52,000, chances are it will have a hard time finding coverage with a loss ratio of 71 percent.
In addition, expected losses are trending down for many construction business categories. This means if a company’s losses stay flat year over year compared to the rest of its industry class, it looks worse to insurers and rates will increase. For example, electrical wiring contractors are expected to have 20 percent fewer losses now in Minnesota than in 2004. If a contractor stayed flat, it would be 20 percent above the norm and looking at inflated premiums.
Experience Modification Factor
An additional consideration is that as losses increase, so does a company’s experience modification factor (often called e-mod or mod). This is a multiplier used in workers’ compensation premium calculations. An e-mod of 1.0 is considered average and means a company will pay average workers’ compensation rates compared to other similar businesses.
By reducing losses, a company’s e-mod will go down as will workers’ compensation costs in the future. If a company pays less than its competition, it has a competitive advantage. But, if its e-mod rises above 1.1, it will be placed on an Occupational Safety and Health Administration (OSHA) watch list.
Most importantly, if a company’s e-mod increases, it will be eliminated from bidding opportunities. General contractors and government entities often will not hire any subcontractors or other construction firms with high e-mods. While the exact number varies by firm or entity, the higher the e-mod, the fewer opportunities a contractor will have to compete for business.
The National Safety Council reports that for each dollar spent on the direct costs of an accident (medical expenses, indemnity costs, property damage, etc.), a company may spend up to $4.50 because of additional hidden expenses. Other studies show expenses may be as high as 10 times the cost of an accident. Costs include production down time or decreased quality, the expense of training new or replacement employees, the burden of renting replacement vehicles or other equipment, decreased employee morale, loss of customers and goodwill, and higher insurance premiums.
If a company becomes known for high losses, its best employees will leave to work someplace safer and it will have difficulty finding quality replacements. Plus, it will have to offer these replacements additional benefits to entice them to join the firm.
What Can Be Done?
Most construction firms focus loss-prevention efforts on unsafe conditions, such as trenches or railings, or other OSHA compliance issues. However, most accidents are caused by unsafe acts. For example, a railing may be installed securely, but are employees warned against leaning over it in an unsafe manner? Or, how often do managers ensure employees are wearing the ear plugs distributed to them?
Establishing a culture of safety when a company is smaller is easier than when it’s large or growing. It begins with top management support and requires continuous monitoring, communication and enforcement.
As a firm grows, it likely will seek alternatives to standard insurance products. This sector of the marketplace includes options from high-deductible plans and captives to self-insurance. These possibilities provide balance sheet advantages to high-performing companies and often offer tax advantages. But these types of risk-transfer programs require companies to maintain predictably low loss ratios and a true dedication to safety.
One company moved to a high-deductible insurance program and immediately saved $210,000 off its workers’ compensation premium by assuming a $250,000 deductible. By doing this, and keeping losses down, the company has been able to upgrade equipment, become more productive and increase profits dramatically—critical components to successful corporate growth. Finding an accountability partner that understands the construction industry and its risks can help keep a company on track.