A recent press release states, "The California Secretary of State announced today that a ballot initiative to require health insurance companies to publicly justify and get approval for rate increases before they take effect has qualified for the 2014 ballot." The release goes on to state, "the initiative would require health insurance companies to refund consumers for excessive rates charged as of November 7, 2012 even though voters will not vote on the initiative until a later ballot."

The President of Consumer Watchdog stated, "Californians can no longer afford the outrageous double-digit rate hikes health insurance companies have imposed year after year, and often multiple times a year. This initiative gives voters the chance to take control of health insurance prices at the ballot by forcing health insurance companies to publicly open their books and justify rates, under penalty of perjury. Health insurance companies are on notice that any rate that is excessive as of November 7th 2012 will be subject to refunds when voters pass this ballot measure." This effort was supported by State Senator Dianne Feinstein and California Insurance Commissioner David Jones.

Is there more to the story? Is there something else we should be considering? Is it really this obvious that this is solving a major concern or problem?

As with most sensational statements, there is far more to consider as it relates to the affordability of health insurance. As a professional actuary for more than 41 years, I am afraid there is far more to this story than has been described by the proponents of this initiative. The remainder of this article will address some of the most obvious issues.

Do Carriers Intentionally Price Gouge Their Customers?
Although there always seems to be exceptions to the norm, carriers set rates based upon their historical costs and a reasonable projection of what might happen in the future. These rates are developed by professional actuaries who are subject to Guidelines for Professional Conduct that govern their analysis and review methodologies.

Rates are not made subjectively, but rather based upon extensive analysis of what costs have been. Actuaries spend endless hours reviewing the claims experience, analyzing utilization and cost levels, developing estimates of inflationary trends, analyzing operating costs and carefully projecting what future rates will need to be in order to cover costs and produce needed margins. When prior rates are inadequate, premium rates are increased on particular plans to avoid losses.

This process is very systematic and based upon detailed actuarial analyses. This process is not arbitrary or capricious, but can be challenging for some product lines. I know of no competent carrier that intentionally tries to gouge its customers, but rather the opposite. Carriers work hard to find ways to provide the greatest value to their customers and keep rates as low as possible.

Why Do Premium Rates Go Up So Much?
There are many reasons why rates increase but the most prevalent reason is the high cost of health care. Most of the premium goes to pay health care bills. Under health care reform at least 80% - 85% of the premium goes to pay for health claims. The carrier has little control over these costs other than their efforts related to negotiating discounts and in the impact of their care management activities. The carrier is subject to the prices charged by health care providers. Hospitals charge what they want to charge and carriers try to keep these down by negotiating and maintaining discounts from billed charges.

Since the government sponsored programs pay deeply discounted prices for Medicaid and Medicare members, sometimes below actual cost of care, the carriers are subject to a significant cost shift, paying prices much higher than their governmental counterparts. When providers increase their prices, carrier costs automatically increase. Other than the limited impact of regulation on prices for Medicaid and Medicaid patients, there is no oversight of what providers charge for their services. The fear by providers of the pending impact of health care reform and how it will expand the Medicaid population has resulted in some dramatic increases in provider charge levels to carriers.

In addition to the increases in provider costs, premium rates increase for other factors which include:

• Aging: as members age, their costs increase as much as 1.5% - 2.0% per year
• Selection bias at time of lapse: there is a strong tendency for a bias in lapsed or terminated members. The healthier members tend to lapse more quickly than others since they are more easily able to find alternate coverage. This tends to increase average costs about 1% - 1.5% per year, especially on individual and small group coverage.
• Impact of underwriting: As individuals are reviewed by carriers for medical conditions at time of enrollment, more healthy individuals are enrolled. As time passes, the impact of this underwriting selection wears off and as a result the average costs increase by as much as 2% - 3% per year.
• Deductible leveraging: As costs have increased over the years, individuals have preferred higher deductible programs to keep their costs down. Effective trend rates are higher on higher deductible programs based upon a concept known as deductible leveraging, even though the underlying trend is identical to that for a lower deductible program. For example the effective trend for a $3,000 could be a third larger than for a lower deductible. For example, for an underlying trend of 10%, the leveraged trend for a $3,000 deductible is 13.2% or 3.2% greater than what is expected.
• Utilization trend: In addition to changes in what providers charge, the actual rate by which patients consume services is higher each year, by as much as 1% - 1.5% per year. Some services increase more rapidly.
• Unit costs vs. CPI: National CPI statistics for health care are based upon a common market basket of services and do not reflect a reasonable norm from which to expect health care services to follow. Recent CPI statistics show a general economic trend of no more than 3%, with their medical statistics showing 5% - 6%. Carrier trends have been even higher for many reasons including the above factors.

The Unique California Situation
In most states the insurance commissioner has the authority to regulate rates carriers use for some of their products. Historically in California, the commissioner's authority was somewhat limited. They required filing of some rates, but did not have the authority to stop a carrier from using a proposed rate or rate increase. They were able to exert some pressure, many times strong pressure, to stop a carrier from large rate increases, but if a carrier wanted to proceed they usually had the right to do so.

In recent years, the department resorted to some public pressure, some negative PR, and essentially threats to the carriers. The proposed initiative gives them the "authority" to do something meaningful, not just veiled threats. So as far as that is concerned, it is good to give more real enablement to do something meaningful to hold all carriers accountable for their actions. I do not believe there is any real concern about carrier behavior, at least among the major players.

The Real Issue
It's always better to deal with the real cause of the problem, not just undesirable symptoms. If headaches are caused by a brain tumor, it is better to fix or remove the tumor, not just take a stronger pain killer. If the Insurance Rate Public Justification and Accountability Act is to fix the healthcare cost problem, then it is taking action on a symptom of the problem, not the real cause.

As discussed above, there are multiple reasons why health insurance premiums increase. Regulating the carriers alone doesn't solve any of the underlying problems. It restricts the behavior of one of the middlemen. It doesn't get to the core problem. It definitely will have an impact, but if not kept in check, will create perhaps even greater problems, potentially driving some carriers out of the market and perhaps transferring more of the problem to additional government bureaucracy.

Although the author is not a big fan of increased government regulation, some regulation or legislation focused on the prices providers are able to charge for services might be more beneficial. At least the major driving force of premium rate increases would be more stable and controlled which would keep premiums more in line.

Proposed Solution
Although fraught with additional challenges, my favorite solution to the provider charge driver is a shift from today's system which has different prices for different payers to a system where all payers pay the same price (i.e., called the all-payer system). No matter what type of coverage a person has, the carrier/administrator would be charged the same price. This means that there would be no bias against government payers vs. private sector payers. This would increase the cost for the government for Medicaid, but would substantially reduce what the private sector pays.

Our firm's analysis shows that setting the prices at Medicare payment levels for all patients would actually be a close proxy for a reasonable price. Private sector prices would drop in most markets by 15% - 17%. Medicaid prices would be increased to a reasonable Medicare payment level. Providers would have no reason not to take any patient since each patient brings the same revenue.

This would also level the playing ground for managed care plans and carriers since network differences would be eliminated. The plans could compete on more important items such as care management effectiveness, clinical efficacy, comparative effectiveness, and quality of the provider network.

Under this approach, Medicare would be the agency essentially regulating the reasonableness of prices. Significant administrative costs would be eliminated from both the carriers and the providers.

There would be a cost to the various states for raising the price they have to pay for Medicaid beneficiaries since they often have to pay 50% of the cost of these patients. Some of this could be offset by some increased federal payments from the savings generated in the system.

Bottom Line
California's proposed initiative is interesting but probably not as big of a deal as it could be. Here's hoping for some "real" legislation that could save more of us more "real" dollars and eliminate some of the administrative costs of the current system.

It's a safe bet that claims will not have a happy ending if the treating physician has a history of being associated with poor claim outcomes. In fact, physicians rated poorly in analytic studies based on past performance are 100% predictive of high costs and inferior outcomes in future claims where they are involved. The question is, how can those providers be identified so they can be avoided?

Applying Analytics
Whether the cause of poor performance is misunderstanding Workers' Compensation or deliberate fraud, the claim results will be dismal. Nevertheless, in order to analyze provider performance, one must know where to find the data, what to look for, and how to apply the knowledge gained from analysis to achieve improved results.

Data can offer a clear picture of actual provider performance. Evaluating physician and other provider performance is a matter of scrutinizing the data using industry research to learn what to look for. In fact, leveraging published industry research is the way to skip the laborious and expensive regression analyses and other predictive modeling methods.

Industry Research Reveals What To Look For
Exposing substandard providers is a matter of integrating and analyzing the data to understand the course of the claim and the providers who were involved. Selecting the data items to monitor can be guided in the first instance by industry research. Organizations such as the National Council on Compensation Insurance, the California Workers' Compensation Institute, and the Workers' Compensation Research Institute continually publish their research based on data they collect from members. These organizations offer research regarding medical issues causing cost escalation in the industry, and usually make results available from their individual websites.

Search
Academia and other organizations produce and publish research, as well. The best way to access other research is to use Google or other search engines to find research studies regarding specific issues and interest areas. For instance, if the concern is low back pain, simply use Google to find research and scholarly articles on the topic as it relates to Workers' Compensation.

Indicators Of Performance
When the indicators of performance are identified, they can be tagged in the data to analyze individual providers. Providers associated with a preponderance of negative indicators will fall into the lowest class category. On the other hand, those whose results are exemplary will rise to the top — best in class.

Where To Find The Data
Billing data tells the story of diagnoses, treatments and the billed amounts. However, billing data by itself is never broad enough in scope to evaluate providers because it tells only a part of the story. Claim adjudication level data tells another part of the story. It describes the actual paid amounts, return to work, the amount of indemnity paid, and whether legal was involved. But there is more.

Analyzing Pharmacy Benefit Management data is imperative. Overuse of prescribed narcotic pain relievers is now a major concern in Workers' Compensation medical management. Prescribing excessive opioids is unconscionable, but the guilty are often not identified and avoided as they could and should be.

Provider performance should be scored by claim outcome combined with costs and other factors. Unless the initial injury was catastrophic, return to work following a workplace injury is often a function of medical management that should be measured. Analyzing multiple data indicators from disparate data sources is powerful in describing physician performance. It is also objective and fair.

Integrating The Data For Analysis
Any one Workers' Compensation data source by itself is inadequate for the purpose of evaluating provider influence. Only the broad scope of data concerning a claim can provide a clear picture of the claim and provider culpability in outcome. Therefore, collecting the data from its various sources (billing or bill review, claim adjudication systems, and pharmacy data), then integrating current and historical data are crucial steps in provider performance analytics. The next steps are identifying, evaluating, and monitoring the data elements that are indicators of performance both from the medical and Workers' Compensation viewpoints using research as a guide.

Link Analytics To Operations
Analytics results of any variety that remain in graphic form, in a brochure, or pinned to a wall are useless in the effort of actually containing costs. The findings must be functionally applied to operations to make them actionable. Information regarding best (and worst) in class doctors identified through the methods discussed here must be made available to network managers and others in a usable form. Moreover, the information should be specific, current, dynamic, easily accessible, and contain objective supportive detail. The work of analytics is not complete until its results are operationalized and actionable.

On July 26, 2012, a federal judge in Las Vegas ordered Prospect Airport Services, Inc., a provider of wheelchair assistance services to airline passengers, to implement extensive measures to prevent future sexual harassment.

After agreeing to a monetary settlement of $75,000 in a lawsuit brought by the the Equal Employment Opportunity Commission, Prospect refused to agree to any prospective relief to prevent future harassment. The Equal Employment Opportunity Commission petitioned the court for an injunction and order directing compliance.

The judge issued an order prohibiting Prospect from further violating Title VII as it relates to sexual harassment for a period of five years. Prospect must develop a policy and procedures for handling reports of sexual harassment and an effective investigation process for all harassment complaints. It must also "appropriately discipline management and human resources staff for failure to comply with such procedures and provide annual sexual harassment training to all supervisory employees."

The Equal Employment Opportunity Commission will monitor compliance and can haul Prospect into court again for any failure to comply with these orders or for damages based on new harassment incidents.

The Equal Employment Opportunity Commission had charged the company with failing to address complaints of unrelenting sexual advances toward a male passenger services assistant by a female co-worker. The employee, whose wife had passed away, received sexually suggestive notes and unwelcome advances. He rebuffed the advances and brought the notes to the attention of a general manager who made light of the situation and failed to stop the harassment. There was no effective company policy at the time to address the issue.

Over the course of a year, the harassment escalated to a near-daily basis, including offensive remarks by co-workers about his sexuality due to his rigorous rejection of the sexual advances. Despite his repeated complaints to management, the hostile work environment ended only when he resigned.

The Equal Employment Opportunity Commission's press release states: "Today the court has spoken to affirm the importance for all employers to have effective policies and procedures in place to prevent discrimination in the workplace ... A strong policy, meaningful training and a swift response to complaints help to contain an existing hostile work environment or to prevent one from arising."

Under California's Fair Employment & Housing Act (FEHA), failure to "take all reasonable steps to prevent discrimination or harassment from occurring" is a separate unlawful employment practice.

In a precedent-setting decision against a small law firm, the Fair Employment & Housing Commission (FEHC) determined that the Department of Fair Employment & Housing (DFEH) can prosecute an action for such failure, even when the underlying claims of harassment and retaliation aren't proven.

In DFEH vs. Law Offices of Jeffrey Lyddan, the Fair Employment & Housing Commission determined that Lyddan's statements, gestures and cartoons directed toward a paralegal, while often in bad taste, did not rise to the level of objectively severe and pervasive harassment that interfered with her ability to perform her job duties. Nevertheless, it supported a "stand alone" action by the California enforcement agency for failing to take all reasonable steps to prevent harassment from occurring. Without actionable harassment or retaliation, such a claim may not be actionable by a private litigant in a civil action.

The Commission found that Lyddan failed to maintain an anti-harassment policy, did not attend harassment training, and failed to order a fair and impartial investigation into the paralegal's charges of harassment presented in her email when she resigned. Therefore, Lyddan was liable for failure to take all reasonable steps to prevent harassment from occurring.

California's Fair Employment & Housing Act requires "effective remedies" that will both "prevent and deter" discrimination. This is why the Equal Employment Opportunity Commission and the Department of Fair Employment & Housing require employers to adopt significant future anti-discrimination practices and conduct widespread training as part of their settlement agreements.

The affirmative duty to prevent future harassment goes beyond sexual harassment to other hostile environment claims, including disability, as is seen in Espinoza v. Orange County, in which an employee was awarded more than $850,000 after harassment by his co-workers and indifference by the County to his complaints.

Failure to prevent future discrimination is also a separate unlawful employment practice in disability discrimination lawsuits. The Department of Fair Employment & Housing has obtained settlements and Commission decisions with affirmative requirements for expanding reasonable accommodation procedures, adopting preventative practices and training in several pregnancy and disability discrimination actions in the last 18 months.

In DFEH v. Acme Electric, the Fair Employment & Housing Commission handed down the largest award in its history to a sales manager with cancer when his employer violated California's Fair Employment & Housing Act by ignoring the duty to engage in a good faith interactive process, refusing to reasonably accommodate his disability and "failing to take all reasonable steps necessary to prevent discrimination from occurring."

Prevention Strategies

• Update your discrimination prevention policies and periodically audit their enforcement — even before someone complains.
• Make sure your complaint procedures have accessible avenues for employees to report harassing work environments.
• Conduct an immediate neutral fact-finding investigation with every internal discrimination complaint, even when it is raised by a departing employee, because the alleged behavior may still occur with others.
• Update your disability processes to comply with the broad interactive process and reasonable accommodation requirements imposed by California's Fair Employment & Housing Act. California law mandates that leaders receive harassment prevention training every two years.
• Provide training for front-line supervisors on the standards for preventing discrimination or retaliation against employees who seek reasonable accommodations or take leaves of absence for medical conditions and/or disabilities.

Cost Retention and Safety Enhancement: Protecting Your Assets

While construction activities are fluctuating due to the current economic situation, general, heavy/highway and specialty contractors continue to face increasing consumer and regulatory demands and requirements to provide a safe, healthy and secure work environment for their employees.

However, the consequences of theft and lack of security in the workplace are not always understood. Several states have contractor-based trade associations who partner with law enforcement, e.g. the Construction Industry Crime Prevention Program (CICP), which monitors, participates and assists contractors in protecting your assets.

To test your knowledge, Take the Crime Quiz

True or False:

1. Substance abuse is an important factor contributing to crime.
Unfortunately, True. The Construction Industry Crime Prevention Program has been notified that some construction firms have relaxed their hiring standards, including substance abuse polices, because of the severe labor shortage. Employee theft accounts for around 85% of a firm's theft problem. One employee with a substance abuse problem can be a firm's entire theft problem in addition to creating a safety problem on the jobsite.

2. Attitude has nothing to do with theft on a jobsite.
False. Rationalization and opportunity are two of the leading factors in employee theft. The common rationalization from some employees is "The contractor leaves all these tools, generators and equipment unprotected, because they are so rich. Obviously they don't care. Besides, I need a drill at home." Congratulations, you have just had a theft.

Most construction firms provide the opportunity for theft if there is poor or no inventory control at a jobsite, lack of inventory accountability, no one is watching payroll checks, or the firm is willingly handing out replacement tools and materials.

3. So long as employees are working and getting paid, the job is getting done.
True. However, job quality and efficiency can be compromised. Thefts and vandalism can rise in direct relationship to how employees are treated. It is always wise to review your layoff and termination procedures and see that they are carefully and calmly carried out.

Terminations alone account for some of the worst vandalism cases identified by the Construction Industry Crime Prevention Program. The Construction Industry Crime Prevention Program historically had taken a close look at these cases and in each one, the employee was terminated in front of his peers by an angry site manager. While one can sympathize with the site manager's frustration — so often justified — but it can cost him/her dearly in the long run.

All jobsites should be made extra secure, locks changed, and an obvious tightening of security implemented following a difficult termination or layoff.

4. Using Tailgate Safety Meetings to discuss crime incident is detrimental and takes away from production on the jobsite.
False. Many contractors have controlled thefts by using a safety meeting as the basis for discussion. Routine and/or regular discussion of vandalism and theft can control the issue and raise awareness among the employees.

Ask for employee input. Treat the person with the best crime prevention tip of the month with a gift certificate. The majority of employees are honest, but they often perceive the company's attitude as "not caring" because it is never discussed.

5. Posting signage to deter theft or a reward poster is beneficial.
True. Many crimes and theft have been uncovered because of postings and utilizing safety meetings to discuss items such as these. If you belong to a Construction Industry Crime Prevention Program, pass out reward fliers. Ask anyone with information to call the CICP hotline and remind them they can remain anonymous. State that losses are going to be investigated, and make a point of assigning someone the responsibility of securing the jobsite. Be obvious about looking through debris piles and control debris. A clean jobsite presents a concerned, careful attitude that will also send strangers on down the road to look for easier pickings.

6. Crime problems are not an issue in construction.
False. If you don't think you have a crime problem, it probably isn't being tracked. Check with your Safety representative, Risk Manager, Insurance loss control representative or claims adjuster to verify just how much this exposure is causing a problem.

Your safety rep, insurance representative, risk manager, law enforcement and the Construction Industry Crime Prevention Program can share with you various ways in which to lower your loss exposure as well as retain efficiency, productivity and replacement costs.

7. The majority of jobsites are cased during the day, especially for equipment.
True. Crime statistics reveal the job is cased throughout the day, especially for items which return a high dollar value on the black market.

All strangers should be challenged, and all visitors should be required to sign in at the job trailer or with the site manager and the rule must be enforced. Contact your CICP organization for appropriate signage to reduce your liabilities after hours. Signage, as offered by the Construction Industry Crime Prevention Program, offers a round-the-clock emergency crime hotline that is visible and well known to law enforcement and the public. This is a good deterrent.

8. Crime is preventable.
True. Keep padlocks closed at all times. Use only case-hardened padlocks and if you must use chain, it should be case-hardened as well. Check to see that padlocks are closed in recessed covers on bins.

With increasing insurance premiums, contractors cannot afford to ignore the long range implications of crime if they want to improve their bottom line and reduce their liabilities.

9. A suspect, including strangers, often returns to the scene of the crime.
True. They want to gauge the reaction on the jobsite. As Andy Warhol says, everybody has 15 minutes of fame. For contractors, indifference, no "tightening up," and/or a business-as-usual attitude only escalates the suspect's confidence and your theft problem.

Unfortunately, the repeated crimes of contractors' job trailers or tool bins being broken into is an indication of a repeat offender. Besides, they get needed tools every time.

In 2001, California Youth Authority inmates informed the Construction Industry Crime Prevention Program of Northern California that they often vandalized a site and returned early in the morning to watch the site manager "yell and cuss," knowing there would be little or no follow up. This reactive approach to theft gave the offenders the confidence to start up equipment, move it around, and cause more damage.

Proactive approaches to deter crime, theft and vandalism includes handing out reward fliers, addressing crime issues at tailgate meetings, tightening up on inventory control, and security. Motion sensor lights hooked up to alarms are also effective, especially when wired to come on in unexpected areas.

10. Crimes, vandalism and thefts are part of doing business, and insurance covers the losses.
False. Case studies revealed one contractor had sustained a $400,000 judgment. A juvenile raced his motorcycle all over their jobsite, causing major damage. He crashed the bike, resulting in him becoming a paraplegic. The judge ruled they did have "No Trespassing" signs, but they did not have enough!

Three 4- and 5-year-old children started up a backhoe in Berkeley. It took five patrol cars to get them stopped as they crashed into street barricades and generally caused havoc and panic for the residents.

The company was very fortunate: they were not sued by the neighbors, nor by the children's parents for leaving the backhoe with the keys in it outside the locked gate. In addition, the news media did not "showcase" the contractor on the six o'clock news for endangering children who live in a low-income neighborhood. Fortunately, the only injuries sustained were to the equipment.

A contractor's risk manager went pale when the Construction Industry Crime Prevention Program informed him that a drug addict, according to his statement, "needed a ride home" and drove one of their backhoes five miles over county roads, parking it near his house.

The possibilities of a tragedy in these scenarios is very real. Negative publicity, impact to public relations, associated costs and headaches do not need to be outlined for any risk manager, superintendent or owner. Even though the examples listed above are not your employees, the exposure and risk is out there. The bottom line is that the company loses money, injuries occur, and the liability is great, unless you take strong preventive measures to minimize this.

11. If your tools and equipment cannot be positively identified, in most cases the thief is the winner.
True. Mark all tools and equipment with the driver's license number of a principal operating owner in a firm or clear company identification. Employees should be required to do the same. Take inventory. If your site managers can't tell law enforcement or your insurance company what is missing following a theft and/or provide serial numbers, the thief is the winner. However, take caution, blue spray paint and somebody's initials on a bunch of hand tools does not qualify as "positive identification."

Tally your Score
So, how did you score in protecting your assets? Hopefully, 100%. Yet, if not, there are resources to help you. Contact your trade association, your state/regional Construction Industry Crime Prevention Program, and your loss control representative. These organizations can assist you in physical site surveys, law enforcement liaison and recovery of your assets. Be smart and get involved in cost retention and safety enhancement.

Musculoskeletal Disorders (MSDs) represent 28% of all recordable OSHA injuries and account for 33% of the total cost of work-related injuries. Each recordable OSHA musculoskeletcal disorder involving lost time results in an average of 20 or more lost work days, compared to 9 lost work days for all other recordable injury types. Since the enactment of OSHA in 1970, the regulations have evolved to increasingly focus on the reduction of job hazards potentially leading to fatalities, amputations, and other serious injuries. Accordingly, a significant decline in the number of those types of injuries is evidenced in OSHA's records. However, muskuloskeletal disorders and other "soft tissue" injuries continue to plague workers and their employers with no indication of decline.

In fact, all indications point to an increase in muskuloskeletal disorders given that the percentage of workers ages 55-64 will increase by 36% during the next 5-year period while the percentage of workers under the age of 25 will decline. Obviously, older workers are more susceptible than younger workers to work-related muskuloskeletal disorders because of decreasing functional capacity due to degenerative conditions, pre-existing conditions and old injuries. Also troubling about this muskuloskeletal disorder injury forecast is the fact that older workers require longer recovery periods, inevitably driving up direct medical and disability costs. Indirect costs include overtime, training, and lost productivity related to injured workers' inability to perform their normal work. According to OSHA, for every $1 of medical-only claims, employers sustain $4.50 in indirect, uninsured costs.

Safety is an investment in future profitability for every employer and the well-being of every worker. However, an employer must exercise caution in its safety programs so as to avoid OSHA's anti-discrimination policies. Recently, Richard Fairfax, OSHA's Deputy Assistant Secretary, issued a memo addressing employers' safety incentive programs and suggesting that some such programs are merely a pretense to save workers' compensation costs and actually resulting in discriminatory disincentive policies and practices. Fairfax's memo emphasizes that a worker's reporting of a claim is a protected act, and identifies four approaches that potentially expose the employer to discriminatory practices:

1. Taking disciplinary action against injured workers;
2. Penalizing injured workers for failure to timely report an injury;
3. Penalizing injured workers for violation of safety rules; and,
4. Implementing certain performance incentive programs.

Under OSHA, Section 1904.4 (Recording Criteria) the employer must ascertain whether a work-related injury or illness has occurred, and if so, record the appropriate report with OSHA. If the employer is uncertain about whether an actual injury or illness has occurred, the employer may refer the worker to a physician or other health care professional for evaluation. The employer may then consider the health care professional's opinion in determining whether a recordable injury or illness exists.

One vehicle to objectively identify work-related injuries is the Electrodiagnostic Functional Assessment (EFA) Soft Tissue Management baseline program. The Electrodiagnostic Functional Assessment Soft Tissue Management baseline program is the proven non-discriminatory solution to OSHA compliance in the area of muskuloskeletal disorders. This program involves pre-injury soft tissue testing of workers that provides an objective baseline for later reported muskuloskeletal disorder injury claims. When the post-loss Electrodiagnostic Functional Assessment is compared to the baseline EFA, objective evidence is generated to determine if there is an acute injury arising out of the course and scope of employment. If no change is documented, there is no claim and thus, no reportable OSHA incident. Furthermore, no state or federal statues are triggered if evidence shows no sustained injury.

Conversely, if a change is documented, the employer is alerted to a recordable OSHA injury, and can reliably report the muskuloskeletal disorder in compliance with OSHA. More importantly, the Electrodiagnostic Functional Assessment further provides recommendations for site-specific and appropriate muskuloskeletal disorder treatment, resulting in quicker worker recovery, expeditious return-to-work, efficient compliance with OSHA's work readiness requirements, and, ultimately, limiting the employer's exposure and costs.

For more information about the Electrodiagnostic Functional Assessment Soft Tissue Management baseline program, contact the author at MReaston@emergedx.com or 702.234.1014.

Just when you thought that everything was settling down, the "Slither-Ins" from the Dark Side have once again reared their ugly heads. The latest and ongoing attempt to seize control over your claims goes like this:

Employers currently have a minimum of 30 days within which to control the medical treatment of an injured employee. This remains true unless the employee has correctly "Pre-designated" his or her Primary Treating Physician before the injury. If you are smart enough to have a Health Care Organization (HCO) in place, you have a minimum of 90 and possibly 180 days of absolute medical control over the claim. Or, if you have put a Medical Provider Network (MPN) in place, you have cradle-to-grave control over the medical treatment of your injured employee if it is handled correctly by both you and your insurance carrier.

Your ability to retain control is a given unless you do not follow the rules regarding the treatment of an injured employee. It is in the initial stages of the claim that you are most vulnerable and subject to having your control taken away by an attorney/doctor team from the dark side if you do not strictly follow the letter of the law. However, do not despair as we have once again been forewarned of their latest tactic and are ready to meet them head-on.

You Have To Open The Mail Every Day
The current law (L/C 5401) says "Within one working day of receiving notice or knowledge of injury under Section 5400 or 5402, in which an injury results in lost time beyond the employee's work shift at the time of injury or which results in medical treatment beyond first aid, the employer shall provide, personally or by first class mail, a claim form and notice of potential eligibility for benefits."

This is the first place that the applicant's attorney is going to try to get you. If you have not provided the Workers' Compensation Claim Form (DWC-1) to the injured employee, they will claim that you failed to follow the law and will attempt to seize control regardless of the medical control program you have in place. It is therefore important that this requirement be strictly adhered to by the person within your organization who you have designated as being responsible for watching your workers' comp claims.

Next, current law (L/C 5402) says "Within one working day after an employee files a claim form (DWC-1) under Section 5401, the employer shall authorize the provision of all treatment,... for the alleged injury and shall continue to provide the treatment until the date the liability for the claim is accepted or rejected..."

In a previous article, I recommended that each of you change your policy regarding how you deal with the DWC-1 when there is an injury. I stated that it is "best practice" for you to have the injured employee complete the top part of the DWC-1 in their own handwriting at the time of the injury. This gives you a record of what allegedly happened (in the employee's own words) and signed by them. If you receive an amended DWC-1 later from an attorney, we then have a basis to object to the added body parts.

You should then fill in the bottom half of the DWC-1 and give them a completed copy. Under this scenario, you have complied with the labor code and can then either accept the claim or delay it while you investigate the incident to see if it really is work related. The need for this approach has become clearer with the current filing of claims we are seeing.

In a recent claim, the employer's failure to timely provide treatment caused him to lose control of a claim that was covered by his Medical Provider Network. The first the company heard from the employee was through a fax sent by an attorney. The rule on receiving notice by ax is the same as if it comes by mail, i.e. you add 4 days to the notice.

So, if you were to receive a fax on Thursday, you add 4 days and the following Monday becomes your official notice date. Several lawyers have tried to use the date of the fax as their official notice trying to gain medical control because the employer did not act timely in getting the injured employee in for treatment. The law is clear that in order for the date of a fax to be effective as notice, both parties must agree in writing for the fax notice to be effective. So watch these carefully and call if there is ever a question.

Another employer also received a letter from the injured employee's attorney which contained a DWC-1 for his alleged specific injury along with another DWC-1 for a cumulative trauma (CT) claim. The forms were mailed to the employer and not the claims examiner. The letter sat on a desk for several days and was not dealt with in a timely manner. The person designated to handle the company's workers' comp program had not been properly trained in the new rules so that the attorney's letter sat for 4 days on her desk before she decided that it might be important enough to open and should be forwarded to their carrier.

Because of the delay in dealing with the alleged injury, medical control over the claim was lost. The employer had failed to authorize treatment (L/C 5401) within 24 hours as required by the statute as well as failing to have the employee seen by a doctor within 3 days as required by the Medical Provider Network statute (L/C 4616). So what is the message here?

If you have not already done so, review your internal policy regarding how you handle claims, especially the provision of dealing with the DWC-1 form when there is an injury. I again strongly recommend that you have the employee fill out the top part of the form first and you do the same for the bottom section giving a completed copy of the form back to the employee and documenting that you did so.

Next, you must open your mail and deal with it every day. This is the only way that you will protect yourself from attacks from the Dark Side.

This is Part 1 in a two-part series about what employers should expect from their insurance brokers. Part 2 in the series will be forthcoming soon.

Setting The Stage
The world of health care finance is changing and the role of the health insurance broker is changing just as rapidly. The role of a trusted advisor is more important than ever. Health benefits for any size employer demand a benefits professional who has the client's best interests at heart. Employers must explore current benefits offerings and demand a package best suited to their needs.

Voluntary benefits, self funding, and Consumer Directed Health Care are just a few of the many options every employer must discuss with their broker. Many employers are also demanding that their brokers account for their income.

The days where brokers were paid a commission by the carrier and counted on a regular double digit raise simply by telling the employer to re-enroll are gone. Some carriers are changing their compensation model. Instead of paying a percentage commission they are paying per head, also known as a capitation model. This model eliminates the automatic pay raise brokers have been experiencing and forces brokers to explore other options to replace lost revenue.

Employers should insist on a written agreement outlining the broker's commissions and the services they will receive. A good broker will help an employer design a plan, market the plan to carriers, and analyze the costs and benefits of suitable plans. Beyond that, some brokers may handle open enrollment, resolve billing and claim issues, and help communicate with employees, but it's essential to clarify such expectations up front.

If your company is self-insured or experienced-rated, retain a competitive broker group to periodically conduct an independent market pricing comparison. You will pay a consulting fee for such services, but the initiative may result in significant savings.

Discussions regarding containing health care costs have traditionally focused on educating and influencing the employee consumer of health insurance. But now, as soaring costs and growing complexity have become the norm, employers too need to educate themselves in order to understand how brokers are compensated and how they can reap the most value from the employer-broker relationship.

Technology As Differentiator
Just as the Internet has empowered consumers, so has it empowered health insurance brokers. While once the task of acting as conduit between insurance company and policyholder required long administrative hours, computers now allow broker and insurance company to instantly transfer information.

Still, time saved by computer must be made up by competing for a limited and educated client base. The new technology has in part driven a trend towards specialization: brokers are marketing themselves as specialists in a given industry. One might be the specialist in non-profit health insurance while another may specialize in the travel industry. This allows brokers to be aware not just of policy options but also of the typical wants, needs and budgets of a given industry.

What directions technology will propel the industry will be revealed only with time. One thing that remains clear is that Americans do not want to worry about their health coverage and will look to experts for help securing the best service at the right price.

Every broker has the best service and every broker offers the best products, just ask them. What differentiates a broker is their technology. Not only the technology a broker uses in their office but more importantly the technology the broker provides to the employer groups. Most brokers are very reactionary. They provide technology to their clients only when the client demands it. All parties — employers, employees, Third Party Administrators, carriers, and brokers — must utilize technology tools.

Benefits administration software, COBRA administration tools, HRIS, and consolidated billing services are just a few of of the technology tools used by brokers and their clients. The days of brokers providing quotes and enrollments are over.

In the next article in this series, we will explore in more detail how top brokers are using these technologies to run their business.

• inadequate capability: physical/physiological — mental/psychological
• lack of knowledge
• lack of skill
• stress — physical/physiological — mental/psychological
• improper motivation

1. endangers the health, safety or welfare of the workers, the environment or the public;
2. precipitates a higher rate for insurance coverage; and/or,
3. threatens to distract the focus of the workers away from production of the job task.

• Achieve contact with each conflicting party.
• Boil down what the presenting problems are.
• Cope with the problems by developing plans of action.

1. Attending behaviors. Attitude and actions of concern must be shown. This involves good body posture, appropriate meeting place, manners, eye contact, etc.
2. Listening. Excellent listening skills must be demonstrated-not verbally forcing the issue of resolution on others. Facilitators should listen to complaints without judging each party, indicating to them that an objective, neutral ear is listening. This will disarm those in conflict and influence them to sit down and work out a solution.

• What do the participants want to see happen?
• Who or what can help them?
• What else can be done to help out?
• How is the plan to be carried out?
• What evaluation is to be done to tell how the plan is doing?

A captive insurance company that qualifies for the tax exemption found in section 831(b) of the Internal Revenue Code is a time-tested and useful risk management mechanism that offers the entrepreneur excellent tax and financial planning benefits.

It looks simple — form a small insurance company and pay no more than $1,200,000 in annual premiums to it, which are fully tax-deductible and then later remove the profits of the captive at more favorable dividend (for now) or capital gains rates.

But it is not so simple. There are many pitfalls. Aggressive captive providers have proliferated recently who are ignoring common sense risk management and taxation issues to the potential peril of their clients. And they hide behind actuarial opinions and regulatory acceptance arguing that their plans and pricing are perfectly acceptable.

The problem is that actuarial opinions are only as good as the assumptions that the actuaries are given. And regulators examine different issues than the IRS when they are approving a captive's license. The existence of an actuarial opinion or a license does not assure the client that their captive is truly compliant with the complicated tax issues that are involved.

There are two current "hot buttons" that anyone contemplating forming a captive should consider:

Pricing of Risk: Once the types of risks to be transferred to the captive are identified, the next challenge is to properly calculate the premium for such risk. Underwriting is as much an art as it is a science, with factors such as coverage details, loss history, limits, deductibles, exclusions and the financial strength of the issuing insurance company all coming into play along with sound actuarial practices.

Given these variables, it is easy for different people to offer diverse opinions on what an appropriate premium may be. But common sense must prevail. For tax purposes, the IRS will only allow a deduction for premiums that are reasonable in amount. The starting point for "reasonable" is the market rates for the coverages in question. However, market rates are not the end point for small captives, but they absolutely do create a benchmark. If a taxpayer is considering paying premiums that are vastly beyond that benchmark, they had better have very strong and well documented arguments for doing so.

Let's take an actual case in point. A captive provider suggested that a client's captive issue a $3,000,000 excess policy for Employment Practices Liability for a premium of over $250,000. Yet the client already had a $3,000,000 primary layer for this type of coverage for which he had paid less than $12,000.

Given that the primary layer would have to pay out full limits of $3,000,000 in order to trigger a loss on the excess layer, insurance companies would normally charge less than the premium paid for the primary layer of the same size. And when we compared what actual clients paid for this type of excess coverage, we found a rate of about $3.00 per employee. The suggested premium for the captive, however, equated to $808.50 per employee. A review of the actual excess policy language did not reveal any special provisions that could possibly justify such a high premium.

While it is true that a small insurance company may need to charge more than market rates because it has a very low capital base, common sense (and the IRS) would never accept a premium that is 269 times the market rate as in any way "reasonable." [When presented with this argument, the captive provider in question simply stated that they felt that they could defend the premium in the event of an audit. The client was not comforted.]

Terrorism insurance is another area of controversy in the small captive market. It is a coverage that can legitimately be placed in a captive insurance company, but pricing is a serious issue. Given the fact that TRIA does not cover loss of income from a terrorist attack and that such coverage is not easily available in the domestic market, some captive providers have suggested that small captives can charge $500,000 to $600,000 for a $5,000,000 limit of such coverage.

In fact, such a policy is available from Lloyds of London at rates significantly lower than those used by these captive providers. For example, one of our clients, a $100 million (revenues) company in Dallas, Texas was recently quoted a price of $10,000 for $5,000,000 of terrorism coverage that includes loss of income as a result of a terrorist attack anywhere in the United States, not just in Dallas. Lloyds obviously has the financial strength to price risks lower than the average captive, but the disparity between the real market price and the pricing quoted by captive providers with little or no insurance experience once again defies common sense.

One of the basic tenets of risk management is that if the risk of loss is severe, and coverage can be purchased at a low price from the third-party market, it is not a sound business decision to self-insure that exposure. If a client is truly concerned about a terrorism related loss, it therefore would make more sense to buy the coverage from Lloyds rather than self-insure it in their own captive. Except, of course, for the tax benefits of doing so. Thus, the decision to form and fund such a captive clearly indicates a lack of economic substance and is motivated primarily by tax considerations. Such a captive would most likely fail an audit by the IRS.

Of course, even Lloyds might not have the ability to pay a claim in the event of an enormous terrorist event, which could be a reason to self-insure this risk in a captive. But pricing the premium at a "worst case plus" rate is not sensible and would likely not survive an IRS audit.

Finally, terrorism quotes in the captive market rarely take into account individual risk characteristics. If the client is located in a "target rich" area, such as near a nuclear facility, some higher rates certainly can be justified, but common sense says that such a rate is not applicable to everyone, particularly in lower exposure areas.

What about an actuarial opinion? Certainly an opinion that is specific to the actual policy coverages in question and to the client's unique risk characteristics can go a long way to justifying the given premium. But clients must be careful that a proffered opinion truly relates specifically to them and not just to the type of coverage in general. When it comes to terrorism insurance, however, we submit that there can be no such "coverage in general" that makes economic or common sense.

Life Insurance: Whole life insurance can be an acceptable part of a captive's investment portfolio. But that statement has opened the door to abuses — abuses that the IRS is well aware of and is determined to quash. A captive must be formed first and foremost for risk management purposes. The tax benefits that follow are wonderful, but must be secondary, and the investment portfolio then ranks third.

Some life insurance agents (who likely know nothing about property & casualty risk management) are touting the formation of a captive for (effectively) the benefit of purchasing life insurance with the premiums received by the captive. This, in effect, allows life insurance to be purchased with pre-tax dollars. Not only does this approach likely violate section 264 of the Internal Revenue Code (that disallows the deduction, directly or indirectly, of premiums paid for life insurance), it violates the economic substance doctrine.

Again, common sense would show that if the primary purpose of forming a captive insurance company is to buy life insurance with pre-tax dollars, that would not constitute a valid reason to become involved with what is, first and foremost, a risk management vehicle.

It is our understanding that the Internal Revenue Service has a specific internal mandate to find and close captives that are marketed in this manner.

To avoid this issue, we suggest the following: (a) do not purchase a captive from anyone promoting it as a vehicle for the purchase of life insurance, particularly an immediate purchase; (b) make any life insurance decisions a part of an overall investment strategy; (c) do not use any unearned premium to purchase life insurance (which means no purchases in the first year); and, (d) do not use more than 50% of the captive's premiums in such an investment.

These issues of pricing and the use of life insurance are particularly important to the CPAs who are being asked to sign the client's tax return showing deductions to a captive. CPAs now have a higher financial and professional risk when signing a tax return and must be acutely aware of these potential issues with respect to their clients' captives.

Historically, many good business ideas that have tax benefits have been abused and distorted by greedy promoters and unsuspecting taxpayers. The end result is often a complete closure of the benefit by Congress or the IRS. We hope that the few "bad actors" in the 831(b) space do not cause the same result with this excellent risk management and financial planning tool.

Authors
James Landis collaborated with Rick Eldridge in writing this article. Rick Eldridge is the President & CEO of Intuitive Insurance Corporation and, along with James Landis, a Managing Partner of Intuitive Captive Solutions, LLC.

The construction industry's reputation has been tarnished by poor quality performance. Construction defects decrease the satisfaction of property owners and erode the confidence of the financiers, buyers, and end users of construction projects.

Total construction costs are increased by lost productivity, and higher rework and insurance costs. Defective construction undermines the reputations of affected contractors and threatens their profitability.

Until recently, Construction Financial Managers outside the homebuilding sector may not have heard of or thought much about construction defects. However, these defects are now an industry-wide issue.

Likewise, while formerly concentrated in the western states, construction defects are now a national concern to all Construction Financial Managers involved in either general contracting or the specialty trades within commercial building.

With a rise in reported construction defects, companies — now more than ever — need to improve quality during the construction life cycle.

This article discusses the basics of construction defects, and presents the barriers to and indicators of quality construction — in addition to the risk management consequences of poor quality performance.

The Origins of Construction Defects

Construction defects occur at the intersection of construction operations, real estate transactions, contract law, and business insurance.

A construction defect is a component of construction that is not built according to plan, specification, or in conformance to established construction codes and industry standards of care.

To be considered a construction defect in the eyes of the legal and judicial systems, physical damage to tangible property or bodily injury must result from the alleged defective construction.¹ Construction defects can also include the loss of use of the "impaired property" — property that is not physically damaged, but is rendered unusable due to defective construction work.

Unfortunately, in our litigious judicial system, reality does not always match theory. Sometimes, "alleged" construction defects are pursued because attorneys think there's a good chance of winning a verdict or receiving a settlement. This can also happen when a group of people, such as a homeowners association, is "unified" for the purpose of class-action litigation.

In the U.S., the general legal doctrine that governs the sale of property is caveat emptor, or "let the buyer beware." In order to receive legal protection, buyers have a general duty to inspect their prospective purchases before taking possession. The legal system recognizes the inherent limitations of such inspections, and therefore distinguishes between two types of defects: patent vs. latent.

There is a fundamental and legal difference between patent defects found during the course of construction and latent defects that manifest later.

Patent defects are regarded as conditions that can clearly be observed or detected in a reasonably thorough inspection prior to the sale or transfer of the property from the seller to the buyer. In contrast, latent defects are faulty conditions in a property that could not have been discovered during a reasonably thorough inspection.

Types of Construction Defects

The types and causes of construction defects vary and are influenced by many factors, which are commonly categorized into the following eight types:

1. Improper design;
2. Poor workmanship that leads to poor finishing quality;
3. Improper means or methods of installation or fastening;
4. Improper materials;
5. Defective material or poor material performance;
6. Missing or inadequate protection from weather or environmental conditions;
7. Water intrusion/infiltration and moisture; and
8. Soil subsidence or settlement.

These types of construction defects result from one or more common causal factors. Researchers at the University of Florida reviewed the common causes and types of building occupancies most often implicated in construction defects.

This study revealed that 45% of all construction defect claims occurred in multifamily housing.² (A large percentage of which presumably relates to condominiums, given the potential for class-action litigation by homeowners associations.)

Another major study found that "...84% of claims are associated with moisture-related defects in building envelope systems (69%) and building mechanical systems (15%)."³

Causes of Construction Defects

The most common causes of construction defects are: 1) the nature of the construction industry itself, and 2) climate, weather, and environmental factors. Let's look at how scheduling pressures and sequencing issues are driven by both causes, and review their potential negative impact on construction quality.

Scheduling Pressures
Contractors face increasing demands for shorter schedules and faster project completion. The potential adverse effects of these types of pressures include cost overruns and nonconformance to specifications, as well as other quality issues.

As these increased schedule pressures contribute to compromised quality performance, the number of construction defects increases. The rework necessary to rectify these quality issues also adversely impacts productivity — and jeopardizes the project's overall profitability, as well as the profitability of all parties involved.

Sequencing Issues
A problem related to scheduling pressures is the improper sequencing of material delivery and/or subcontractor trades. Construction projects require precise coordination of various suppliers and subcontractors. Conditions are ripe for latent construction defects when weather-sensitive materials, such as drywall boards, are delivered to a jobsite before the building has been enclosed and is weather-tight.

For example, if a load of drywall is exposed to moisture from humidity, dew, or rain, then the likelihood of mildew or mold increases. Likewise, if the various subcontractor trades are not properly sequenced, then additional punch list items or rework can result.

Exhibit 1 below summarizes quality management barriers and lists the factors that contribute to construction defects at the industry, company, and project levels.

Exhibit 1: Barriers of Implementing Quality Management in the Construction Industry

The Role of Insurance

Risk Financing
Insurance is a financial risk transfer method that may help resolve construction disputes or litigation that involves alleged defective construction. Insurance pays on behalf of an individual or business when two conditions are met:

1. It is proven that one party is liable for causing or contributing to the construction defect; and
2. It is determined that the party has a legal duty to correct or otherwise remedy the defective conditions.

Commercial General Liability Coverage
Specifically, Commercial General Liability Insurance is purchased to cover payments for bodily injury and property damage sustained by third parties arising out of business operations. These damage claims are known as third-party liability claims.⁴

Construction-related Commercial General Liability property damage losses are further divided into losses that occur during two different timeframes: the course of construction and completed operations.

Course of Construction
The course of construction involves construction operations from the inception of building activity until a certificate of occupancy (CO) is issued for the facility.

Completed Operations
The completed operations aspect of Commercial General Liability coverage responds to allegations of construction defects. The completed operations component provides coverage from the time a certificate of occupancy is issued through coverage termination.

The increased severity and volatility of losses in construction insurance primarily stems from losses with a "long tail" — the length of insurance coverage extending beyond the term of the policy.

It's common for the coverage period to extend between 3-10 years (often to match the length of the statute of repose and/or statute of limitation). During the extended coverage period, latent conditions often manifest as insurance claims with associated monetary losses. In construction insurance, the long tail results from alleged and actual construction defects.

Completed Operations vs. Products-Related Coverage
While coverage for completed operations and products are included in the same limit of the policy, there is a distinction between the two types of coverage.

A general rule of thumb: Once a product is incorporated into real property, it loses its characteristic as a product and is considered a "completed operation."

For example, a contractor that is also a supplier of ready-mix concrete has a "products liability" exposure until the time the concrete is incorporated into the building. At that point, it becomes a "completed operation," and is subject to all of the provisions of that coverage part — including the potential to respond to construction defect claims.

Statute Of Repose vs. Statute Of Limitation
Generally, companies involved in construction seek to purchase completed operations insurance to correspond with either the legal statute of repose or statute of limitation. Both the statutes of repose and limitation restrict the total time period contractors are subject to liability.

What's the difference? The statute of repose is a specific legal limitation or length of time following the completion of the project in order to provide the owner or occupants an opportunity to discover if defects or non-conformance to specifications need to be rectified by the contractor. The statute of limitation bars legal action after a specified length of time following the discovery of a deficiency.

These statutes are state-specific and are used to adjudicate alleged construction defect cases in state court systems. After the expiration of the statute of repose, buyers have no standing to bring legal suit against the property seller.

The statutes of repose range from a low of four years in Tennessee to a high of 15 years in Iowa.⁵ The most common length of statutes of repose is either seven or ten years.

However, statutes of limitation are shorter for bringing suits once damage is discovered and usually range from 1-3 years.⁶

Subcontractors & Contractual Risk Transfer
Contracts govern how expectations are communicated, responsibilities are assigned, and risks are allocated to facilitate successful project execution.

Generally, subcontractors are expected to assume responsibility for the work they perform (both financially and legally). One of their legal responsibilities is to purchase insurance as a means to protect the owner and all other parties.

A gap between legal and financial risk transfer can occur if subcontractors are not able to obtain the required types of insurance coverage. This gap can also occur if the required policy limits cannot be obtained or if the coverage has exclusions for particular perils or exposures that are likely to occur during the course of construction.

Quality Management In The Construction Industry

When strictly adhered to, quality management systems instituted by contractors can minimize the need for rework on construction projects.

As the amount of rework decreases, a contractor's performance increases in the areas of quality, productivity, and profitability. Unfortunately, a universal or standard definition of "quality" does not exist within the industry. Instead, many competing definitions are used, including:

• Customer satisfaction
• Contract requirements met
• On-time completion
• Conformance to specifications
• Project completed within budget
• No rework required within warranty period
• Zero punch list items at project turnover
• Continuous quality improvement

Leading Indicators
In my article on "Risk Performance Metrics" (in the September/October 2007 issue of CFMA Building Profits), lagging indicators were defined as "passive metrics of prior results without consideration of the activities that influence the results." So, lagging indicators are retrospective and trigger reactive, tactical responses.

In contrast, leading indicators are metrics established to gauge the effect of activities designed to prevent or counter the metrics that are monitored by the lagging indicators. Accordingly, leading indicators are drivers of strategic and proactive activities consistent with continuous improvement. Exhibit 2 below presents leading indicators for project quality management for the three distinct phases of construction: pre-construction, course of construction, and post-construction.

Exhibit 2: Representative Examples of Leading Project Quality Indicators

The ability to deliver a quality project safely provides a significant competitive advantage among contractors. The integration of safety with quality management enables projects to be built within budget and schedule constraints.

Safety performance is improved through the quality management discipline of "continuous improvement" that increases communication and feedback among workers and supervisors. Similarly, projects with reduced safety incidents experience improved quality, schedule, and cost performance.³

As a risk management professional, I've seen proactive construction companies take various actions to minimize the adverse effects of quality issues.

These actions are divided into the following stages or phases:

• Awareness
• Prevention
• Detection and measurement
• Mitigation
• Documentation for defense

The 5 Ps & 5 Rs
Similar to the 6P model as described in my article on "Return to Work: The Foundation for Successful Workforce Development" (in the September/October 2008 issue of CFMA Building Profits), the 5P and 5R models are offered to help increase awareness of construction defect prevention and response. (See Exhibit 3 below)

Exhibit 3: Strategic Processes for Construction Defect Prevention

The 5 Ps are proactive steps focused on quality control and assurance that help prevent construction defects: Program, Policies, Procedures, Protocols, and Practices.

The 5 Rs are reactive steps taken in response to potential or suspected occurrences of defective construction: Report; Response/Investigate; Root Cause Analysis; Remediate, Repair, or other Recourse; and Recordkeeping.

For construction companies, there are potential consequences of not implementing effective quality management systems. One adverse consequence is unintended and undesirable exposure to risk.

As shown in Exhibit 4 below, poor quality performance impacts a company's reputation and has financial, operational, insurance, and legal consequences.

Exhibit 4: Risk Management Consequences of Poor Quality Performance

Industry Changes Since 2009: Proceed with Caution

Since this article first appeared (in the January/February 2009 issue of CFMA Building Profits), the construction industry has experienced challenges and changes that have led to the continued emergence of construction defects as a pressing industry issue. Most notably, the U.S. and global financial crises have contributed to the protracted economic recession and lingering recovery.

There have been some positive outcomes as a result of these changes, including growing awareness of supply chain risk management practices, improvements in building envelope design, the adoption of controls for moisture and water damage prevention, and other construction quality improvement methods and techniques.

However, the aftermath of these challenges includes such negative effects as the precipitous decline in the residential housing and construction markets and marked shifts between private and public construction funding and hard bid vs. negotiated work.

As always, contractors must consider the financial, operational, risk management, and insurance impacts from these and other changes to avoid increased risk.

Specifically, unique challenges occur when contractors pursue business in new states and/or with new partners (owners, subcontractors, and/or joint ventures), use new delivery methods, and involve new types of projects/occupancies and new products and/or materials, with which they have less experience and are beyond their core competencies.

Shifting Sands & Slippery Slopes
The resulting and ever-changing landscape of construction defects has been caused by such factors as:⁸

• State legislation and judicial case law interpretations to the legal definitions of an occurrence, property damage, and resulting loss under CGL policies;
• Increased contention between GCs and subcontractors on matters of contractual risk transfer;
• The expansion of "business risk" exclusions and exclusionary insurance endorsements vs. the growing availability of construction defect coverage;
• Unproven impacts of innovative design features, new products, and integrated technologies involved in Leadership in Energy and Environmental Design (LEED) and green construction; and
• The emergence of e-discovery in construction litigation.

Unfortunately, the lack of aggregated industry data on alleged vs. actual construction defects increases the challenge of finding proven proactive solutions that are focused on prevention. As a result, information has been focused on reactive mitigation strategies based on lessons learned from construction defect litigation outcomes.

Moving Forward

The adoption of quality management systems can positively influence the construction industry's reputation and contractors' bottom lines.

Moreover, those companies that elect to implement quality management systems are more likely to gain a competitive advantage in the form of improved productivity and reduced rework, which leads to higher profitability.

Upfront coordination and rigorous pre-project planning can reduce schedule dynamics that disrupt the entire system of a construction project. Successful project management entails quality, risk, and safety management among owners, designers, engineers, contractors, subcontractors, and suppliers.

Ultimately, with respect to construction defects, prevention is a better strategy than mitigation, and mitigation is a better strategy than litigation.

As incidents of alleged construction defects rise, they pose a serious risk to your company's tangible and intangible assets.

It's critical for contractors to fully understand the specific state legislation and case law that governs construction defects in the jurisdictions in which their companies have completed projects or plan to perform work.

Active, ongoing collaboration with construction specialty professionals in the areas of law, insurance, surety, and accounting can help your company stay abreast of the ever-changing landscape and make informed business decisions.

Endnotes:

¹ Wielinski, Patrick J. Insurance for Defective Construction, 2nd Edition, 2005. International Risk Management Institute, Inc. (IRMI). Dallas, TX.

² Grosskopf, K.R. & Lucas, D.E. "Identifying the Causes of Moisture- Related Defect Litigation in U.S. Building Construction." www.rics.org/site/download_feed.aspx?fileID=3158&fileExtension=PDF.

³Grosskopf, K.R., Oppenheim, P. & Brennan, T. "Preventing Defect Claims in Hot, Humid Climates." ASHRAE Journal, July 2008, 40-52.

⁴ For more information on Commercial General Liability, see Wm. Cary Wright's article, "The Anatomy of a CGL Policy," CFMA Building Profits, January/February 2009.

⁵ "Statute of Repose Limitations for Construction Projects." American Insurance Association, Inc., January 7, 2007.

⁶Ibid.

⁷ Chang, A.S., & Leu, S.S. "Data Mining Model for Identifying Project Profitability Variables." International Journal of Project Management, April 2006, Volume 24, Issue 3, 199-206.

⁸ "Construction defects: Managing risk, covering exposure." Business Insurance, www.businessinsurance.com/section/NEWS070102.

© 2012 by the Construction Financial Management Association. All right reserved. This article first appeared in CFMA Building Profits. Used with permission.