Tag Archives: construction industry

Visions of Safety and Pictures of Success

Sight is the savior of the insurance industry. Where insurers were once lost, where they were once blind, they can now find their way because they can see the way to safety and success. That technology allows policyholders to see everything is the best insurance policy of all. That video cameras reveal what we cannot otherwise see, that we have the power to prevent accidents by avoiding the most egregious ones altogether, that I continue to say what I see—that I have written about this issue twice before—should inspire insurers, I hope, to acknowledge that what is essential to one industry, the construction industry, is also essential to the insurance industry. Specifically, video cameras are a necessity for crane operators and their fellow construction workers.

Video cameras are a necessity for all people at or near a construction site, because were a piece of equipment to fall and kill a worker, as it did in Bradenton, Fla.; because were a similar accident to happen again—that it will happen again is almost inevitable—insurers will have to pay tens of millions of dollars in damages, unless they accept the truth by seeing it for themselves: that construction is perilous; visibility (without video cameras) problematic; safety precarious.

See also: Construction Safety: Listen, Learn and Lead  

Sight is not the problem. The inability to see without the help of video cameras is—and will remain—a problem, not because crane operators do not have perfect eyesight, but because no person can see what is not in his line of sight. The refusal to subsidize the purchase of video cameras, or to give policyholders incentives to buy and install these cameras, is the biggest problem facing insurers on behalf of the construction industry.

According to Chris Machut of HoistCam, lack of sight is no oversight. Which is to say crane operators cannot see what they need to see—what they have a right to see—if they do not have video cameras to assist them. “Far from increasing liability, video cameras lower the risk of accidents or injuries. In so doing, insurers can save more money than they spend regarding payouts to construction companies,” Machut says.

If insurers are reluctant to change, and they are, it is more a matter of operations than opposition. They run their companies like they underwrite their policies, with caution, which can cripple their ability to change, which can—and has—cost them the chance to stay ahead, which may cost them clients in many industries.

See also: Let’s Open Our Eyes to Work Safety Issues  

If insurers listen to construction workers, if they do more than listen, they will know where to look and what to see. They will see the images that crane operators see, courtesy of the video cameras on construction cranes, that make it less expensive and more efficient for these workers to do their jobs. If insurers embrace today’s technology—if they have even modest expectations about the present—they will nonetheless make tomorrow a vision to behold. That vision is worth the investment. That investment starts with video cameras. That vision is too great to ignore.

Construction Risk Management in the Rollercoaster Recovery

Although the long-term forecast for the construction industry is robust, it is experiencing malaise as it recovers from the recession. Week after week, positive reports from the government are offset by negative industry news reports, only to be followed by yet another optimistic outlook. So goes the rollercoaster recovery.

The continuing uncertainty of the economic recovery makes strategic risk management more important than ever for contractors. Insurance and risk management — which are major expenses — can be a source of competitive advantage or disadvantage for construction firms.

Insurance is an important product, and its purchase should never be considered as a commodity. The value of having the right insurance coverage (by means of policy, endorsement or extension) and limits cannot be overstated. There are direct, indirect and opportunity costs, all of which can affect your bottom line. The intelligent buyer knows there is a difference between price and value.

Insurance is also an important service. The existing trends and emerging opportunities in the construction industry are driving specialized and customized insurance, surety and risk management solutions. The discipline of strategic risk management is one such development. It is recommended that your company partner with your insurance adviser to conduct a strategic risk analysis and to evaluate your company’sresilience and risk accountability culture.

It is important to embed a risk management mindset into strategic business planning processes. As a strategic discipline, risk management serves several important purposes, including decision making, risk and cost allocation and business-process improvement.

Contractors need to be mindful of two important concurrent developments:

1. Pressures in the construction insurance market
2. Changing nature, scope and complexity of risk in the construction industry

Pressures in the construction insurance market

The construction insurance market is experiencing pressure from various disruptive forces. Some of these occurred independent of the recession while others were made worse by the recession. In either case, these trends will continue to be disruptive:

• Growing severity of workers' compensation losses
• Escalating alternatives to traditional insurance including captives, owner- or contractor-controlled insurance programs (OCIPs/CCIPs) and subcontractor default insurance
• Increasing number of owner insolvencies and subcontractor defaults
• Increasing challenges on property and builders risk placements with coastal wind and other catastrophic loss exposures
• Rising threat of increasing general liability premiums
• Growing pressure on professional liability because of increasing frequency and severity of large design-related liability losses
• Increasing regulatory and administrative requirements for employee health benefits under the Affordable Care Act

Expanding risks in the construction industry

To further complicate matters, the level of risk in the construction industry continues to expand. A number of industry developments are continuing to change the risk profile at the individual company level and for the industry as a whole. The following representative eight industry trends illustrate the growing nature, scope and complexity of risk to be managed by contractors:

1. Expanding use of alternative construction delivery methods, including design/build and integrated project delivery
2. Growing number of accelerated fast-track projects
3. Changing project finance methods, including public/private partnerships
4. Expanding number of joint ventures to meet project capitalization and surety obligations
5. Reemerging skilled workforce shortage
6. Growing reliance on technology, and vulnerability to disruptions of business systems and networks
7. Expanding use of building information modeling (BIM) and online collaboration on construction design
8. Continuing migration of construction defect claims and litigation from residential to commercial construction

A word of caution: This list of risk trends and developments is not exhaustive. Other risk exposures and issues may be important for your company depending on your scope of work, industry sector and geographic region.

Conclusion

Risk is inherent to the construction industry. Risk management is the bedrock of the construction industry. There is opportunity in risk. Strategic risk management is not about saying no to opportunity. Rather, strategic risk management is focused on protecting your business from being blindsided by hidden risks and cascading costs.

Strategic risk management will help you remain calm and composed during the rollercoaster economic recovery. More importantly, strategic risk management helps contractors identify factors and make decisions that improve their competitiveness, growth, profitability and reputation.

Realities of Post-Disaster Data Recovery

The construction industry’s dependence on information technology systems continues to expand with the dramatic shift from document management to data management. With this reliance comes an increased vulnerability to business disruption. Data management, business continuity and post-disaster data recovery requires a shift in mindset from firefighting to fire prevention. Zero disruptions is a bold strategic imperative that provides a competitive advantage by enhancing field productivity, increasing office efficiency, reducing downtime and preventing data losses. Effective data backup and post-disaster recovery protocols are the essential steps to minimize business disruptions.

Data management today requires an enterprise view integrating a company’s increasingly complex networks. Data must be construed to encompass all information generated, received, transmitted, stored and retrieved throughout the organization. Additionally, data must be incorporated from its various physical and virtual locations, including mobile devices. Following are IT trends affecting AEC companies:

  • expansion of email as the predominant form of intra- and inter-company communication;
  • growth of online data mobility project management tools using smartphones and tablets to access and transmit data;
  • increased adoption of document imaging to replace paper recordkeeping files;
  • growth of enterprise resource planning (ERP) platform systems and integration with best-in-class specialty software programs;
  • estimators’ use of the same database to work from multiple locations on complex projects;
  • increased adoption of, and massive data files generated by, BIM;
  • emergence of hosted and cloud-based data recovery systems;
  • expansion of e-discovery in litigation, which raises expectations for (and increases the risks of ) record retention; and
  • proliferation of social media networks combined with bring-your-own-device policies, which creates new portals for hacking, malware and viruses.

The severity of natural disasters and the escalating number of man-made emergencies and technological disruptions compounds the construction industry’s dependence on IT systems. Many of these disruptions “only” result in temporary IT system shutdowns, while others pose a threat to the viability of the business.

A company’s vulnerability to data loss can be increased or decreased by the actions taken (or not taken) with regard to data backup and recovery. A robust business continuity plan is the first step. Companies have many choices when selecting the best way to back up their vital information and mission-critical data.

The Need for a Comprehensive Business Continuity Strategy

Automatic offsite (hosted or cloud-based) data backup protocols at regular intervals are the best prevention for data loss. These backups must be set for every type of data and for every type of device accessing, transmitting or storing information.

Another data recovery strategy is imaging the company’s server and running the restored replica image from a new server in a remote location. However, this strategy requires pre-planning. In a large-scale disaster, obtaining replacement servers may not be possible.

Causes, Costs and Consequences of Data Loss

Data disruption is a reality of the modern work environment. Causes of data loss include:

  • failure to initiate or maintain regular data backups;
  • hardware failure;
  • human error resulting in accidental deletion, overwriting of data or forgetting to add new IT systems/devices to backup protocols;
  • failure to test the backup and data recovery restoration process to determine adequacy;
  • software or application corruption;
  • power surges, brownouts and outages;
  • computer viruses, malware or hacking;
  • theft of IT equipment; and
  • hardware damage or destruction from vandalism, fire and water (rain, flood or sprinkler system discharge).

The consequences of lost data include direct loss of revenue from missing bid submissions or customer orders, direct expenses to pay for technical specialists to help recover data, decreased productivity during the shutdown and costs to re-key or obtain replacement data. For contractors selling directly to consumers, the loss of Internet connection for any extended time could prove costly. Lost data also can result in litigation for breach of confidential information plus adverse publicity.

A 2012 study commissioned by cloud-based data backup company Carbonite revealed 45% of small businesses (defined as fewer than 1,000 employees) had suffered a data loss. Fifty-four percent of the data losses were attributed to hardware failure, and the average cost for data recovery was $9,000.

Real-World Data Loss Scenarios

  • Laptop motherboard failure. A project estimator was working offline when the motherboard crashed. Because of a tight deadline, he had to restart the estimate from scratch. Although the bid was successfully submitted on time, the estimator fell behind on pricing other jobs that the company failed to win.
  • Lost iPhone. Pictures of a project safety incident with documentation of a mismarked “one-call system” utility spot were lost. The photo documentation had not been transmitted to the office, and the contractor lost the request for damages against the utility locating service. Moreover, the smartphone was not properly password-secured, allowing unauthorized access to contacts, client information and company data.
  • Desktop computer backup location not properly mapped to server. When a workstation was upgraded with a new desktop computer, it was not mapped to the server for automatic backup. The computer hard drive crashed, and no files were backed up. Recovery using the old desktop computer was slow, and data created on the new computer was lost.
  • New database not added to the nightly backup protocol. A company purchased a new customer relationship management database and, after a power outage, realized it had not been added to the nightly data backup protocol.
  • Onsite data backup location destroyed. The building housing an onsite backup server was struck by lightning, which started a fire and resulted in a total loss of all current and historical data.
  • Disaster recovery software not properly configured. While conducting a test of a company’s disaster recovery plan, it was discovered that some critical data was not being captured in the backup files.
  • Laptop and tablet stolen from a jobsite trailer. The field equipment had not been backed up for several weeks, resulting in the loss of key project documentation.

Best Practices for Data Management

Data management and IT network administration is a strategic, unique function for all companies. It is not possible to delineate all data management best practices, but the following guidelines should help enhance most companies’ post-disaster data recovery efforts:

  • Determine the company’s recovery-time objectives, and plan and budget accordingly. Identify which functions and systems must remain operational at the time of a disruption or disaster. This requires advance planning and budgeting for necessary systems and technical support services. It also helps prioritize risk-reduction strategies, including investments in data management backup system and security upgrades.
  • Develop a written business continuity plan that outlines specific responsibilities for protecting vital information and mission-critical data. The business continuity plan should include protocols for backup and synchronization of all office systems and virtual/mobile devices. It also should address the frequency and format for testing data management integrity and security, as well as how gaps will be identified and addressed.
  • Inventory the company’s vital information and mission-critical data, and verify it is being backed up. Key considerations include how the data is being backed up, by whom and how frequently, as well as where the backup data is stored. It is important to ensure the data backup and restoration process work as designed.
  • Initiate automatic scheduled backups, ensure the backup data is stored offsite, and test the adequacy of the data backup and restoration methods. Consider the added benefits of imaging the company’s servers to achieve a complete restoration of the data management system
  • Develop a comprehensive diagram of the company’s integrated data management network, including all physical and virtual/mobile subsystems. Ideally, this will be an “as built” blueprint of the company’s configuration consisting of the hardware, operating systems, software and applications that make up the data management network.
  • Institute policies regarding the use of the company’s Internet, including security protocols. Implement policies for user authentication, password verification, unacceptable personal devices and reporting of lost equipment. It is essential to communicate these policies and security protocols to all users and to train new employees.
  • Establish proactive management of the company’s data and IT network. Ensure the company’s network administrator has state-of-the-art tools, including remote access, help desk diagnostics and anti-spam and malware protection. Request periodic updates on all software licensing audits and verification that all security patch updates have been installed on a timely basis. Establish a fixed replacement schedule for hardware and software.

There is good news and bad news regarding business data management and recovery. The bad news is that the need for post-disaster data recovery can no longer be ignored. The increasingly complex and connected business world demands pre-planning for business continuity. The good news is that data management and recovery services are scalable to meet the custom needs of every business regardless of the size and scope of the operation and its degree of data dependence.

Reprinted with permission from Construction Executive, January 2014, a publication of Associated Builders and Contractors Services Corp. Copyright 2014. All rights reserved.

Internal Vs. External Benchmarking Of Insurance Claim Data

Data-driven analysis is a critical decision-making tool for Construction Financial Managers and other industry leaders.

Decision-making is arguably the most important responsibility of company leadership.

Companies that make better decisions make fewer mistakes, and achieve a distinct competitive advantage in the marketplace.

The underlying purpose of benchmarking is to continually improve the quality of organizational decision-making.

Overview
As construction risk management consultants, we help contractors prevent accidents, mitigate claims, and reduce the total cost of risk through a continuous improvement process.

We believe companies must instill management accountability for continuous improvement by linking performance measurement to both prevention activities (leading indicators) and operational results (lagging indicators). As the adage goes:

“What gets measured is what gets done.”

In our consulting roles, we frequently help companies establish realistic performance measures by conducting various types of claim and loss analysis.

This type of data analysis is usually the starting point in a performance improvement process — and a common practice among insurance agencies, brokerages, carriers, and risk management consulting firms.

In addition, we are often asked to conduct a benchmarking analysis that compares one company's claim and loss data against peer companies or to the construction industry as a whole.

Benchmarking
The term “benchmarking” refers to the comparison of a company's performance results against those of similar peer companies. Benchmarking evolved out of the quality improvement movement in the late 1980s and early 1990s.

Its initial intent was to identify leading companies regardless of industry sector, and apply their best practices to improve one's own company. Over time, benchmarking has become synonymous with process improvement.

The traditional view of benchmarking required two separate disciplines focused on performance improvement: measures and methods. Identifying and capturing performance indicators (the measures) is only the first step; developing and implementing performance improvement (the methods) is the second and most important step for the benchmarking process to be truly effective.

The Health Club Analogy
There is limited value in benchmarking without applying new methods to address continuous performance improvement. Performance improvement requires more than the measurement of performance indicators; it requires the implementation of changes in management disciplines to attain improved operational results.

Using only performance indicators without implementing new methods to improve operations is akin to joining a health club and expecting the benefits without actually using the equipment or committing to an exercise program.

Merely jumping on the scale and gauging your weight relative to others doesn't help you achieve your own weight loss goals anymore than comparing your pulse and respiration rate to others helps you attain your aerobic or cardiovascular fitness goals. What matters most is that a person embarking on a weight loss or fitness program stays committed to the process and monitors his or her own progress.

Similarly, we believe the ongoing monitoring of claim and loss data specific to an individual company is even more important than the initial measurement of insurance claim and loss data relative to other companies.

Baselining As Benchmarking
The term “baselining” refers to the internal benchmarking process that occurs when a company compares its performance against its own results year after year. Ongoing, internal monitoring allows a contractor to determine if the company's claim and loss trends are improving or deteriorating, and to make the critical performance improvement decisions necessary to facilitate a change in results.

Referring back to the health club analogy, baselining does not compare an individual's weight and aerobic fitness to that of the other health club members. Instead, individual fitness goals and measures are established, monitored, and tracked to verify continuous personal improvement.

Similarly, a construction company can develop a baseline analysis of its loss cost performance by reviewing loss and claim data for a minimum of 3-5 years. Company results are compared from year to year, and ideally are broken down by operating entity, division, project, manager, or even crew levels.

Exhibit 1 provides a sample of a baseline analysis that compares one company's relative claim and loss performance within all of its operating divisions.

2001-2006 Total Claim Cost per Man-Hours Worked by Division

 

This analysis reviews the historical loss cost data for the entire company and breaks it down into meaningful data relative to each operating division. The total workers' comp, Comprehensive General Liability, and auto liability incurred claim costs (sum of paid and reserves) for each company division over a five-year period were compared to the total man-hours for each division, producing a cost per man-hour figure.

The results illustrate dramatic differences in total claim costs per man-hour for each division. This baseline analysis was the first step in raising awareness of the predominant loss leaders within the company. This increased awareness led to a detailed analysis that established plans of action and realistic cost targets by company division for the upcoming year.

External Benchmarking
We acknowledge that there are numerous benefits to measuring the frequency, type, and cost of insurance claims compared to peer groups and/or the entire construction industry. Such analyses provide the ability to:

  • Identify leading types and sources of claims
  • Establish strategic objectives to prevent the occurrence of common industry claims
  • Increase knowledge of industry best practices
  • Determine operational performance improvement priorities
  • Create awareness among managers and employees about the costs of claims and the impact on profitability
  • Post positive results on company websites and for use in other marketing materials

The Bureau of Labor Statistics provides safety-related data so that companies can externally benchmark injury and illness data against specific industry groups. (Check out the Web Resources section at the end of this article for more information.)

In addition, Bureau of Labor Statistics data is used to calculate and compare OSHA Recordable Incident Rates and Lost Workday Incident Rates, both of which are common construction industry benchmarks. This data is useful when making high-level comparisons within construction industry segments relative to injury and illness rates.

We also use external benchmarking analyses to establish risk reduction, loss prevention, or cost containment goals. In “Risk Performance Metrics” by Calvin E. Beyer in the September/October 2007 issue of Building Profits, a sample benchmarking comparison shows a representative contractor's duration of lost workdays workers' comp cases in median number of days compared against the median duration for the industry. Results such as these can highlight the importance of an increased focus on injury management and return-to-work programs.

The benchmarking analysis in Exhibits 2A and 2B compares a contractor's workers' comp claim and loss performance to an established group of peer contractors in the same specialty trade. (These companies engaged in similar work, and performed in states with similar insurance laws and legal climates.)

WC Claims Per $1 Million WC Payroll by Company

The analysis was based on total incurred workers' comp costs and total number of workers' comp claims as compared to payroll for each entity. Overall, Company D had worse results than the other three companies.

This prompted an in-depth review of Company D's workers' comp losses by division and occupation. As shown in Exhibit 3, the company experienced significant claim frequency and severity issues within the first six months of employment.

WC Claim Count & Cost by Length of Service

These findings triggered the development and implementation of specific activities designed for Company D's new employees.

Below are some of the activities that were incorporated into the formal improvement plan:

  • hiring processes
  • new hire skills assessments
  • orientations
  • daily planning meetings
  • formal training

Other Sources Of Benchmarking Data
Professional associations and industry trade/peer groups also provide comparative data for benchmarking purposes.

The Construction Financial Management Association's Construction Industry Annual Financial Survey is an excellent source for understanding the key drivers of contractor profitability. We use the survey data to determine comparative profit margins for different types and classes of contractors when we calculate a revenue replacement analysis to show the additional sales volume needed to offset the cost of insurance claims. (This technique was highlighted in the “Risk Performance Metrics” article previously mentioned.)

Similarly, the Risk and Insurance Management Society (RIMS) conducts an annual benchmarking survey that reviews insurance rates, program coverages, and measures of total cost of risk.

An example of a peer group data source for benchmarking is the Construction Industry Institute (CII). The Construction Industry Institute is a voluntary “consortium of more than 100 leading owner, engineering-contractor, and supplier firms from both the public and private arenas” (www.construction-institute.org). It develops industry best practices and maintains a benchmarking and metrics database for its participating members.

Another peer group example involves members of captive insurance companies sharing and comparing claim and loss data for the group as a whole. There is a major advantage when a true peer group shares benchmarking data: Such data sharing often leads to peer pressure in the form of increased ownership and accountability for improvement by the companies shown to be the poorest performing members.

We continue to search for more new sources of industry best practices and comparator data. A possible emerging source for the construction industry is the National Business Group on Health. This organization has developed standardized metrics known as Employer Measures of Productivity, Absence and Quality™ (EMPAQ®).

EMPAQ® helps member companies gauge the effectiveness of their injury and absence management and return-to-work programs. The founder and principal of HDM Solutions, Maria Henderson, served as a project sponsor for EMPAQ® from 2003-2007, and co-presented with Calvin E. Beyer on “Return to Work as a Workforce Development Strategy” at CFMA's 2008 Annual Conference & Exhibition in Orlando, Florida.

Limitations Of External Benchmarking
We fear that the increasing popularity of external benchmarking analyses may indicate that it has become a “quick fix” solution or a management fad. When asked to conduct an external benchmarking analysis, we always ask the following questions:

  • What is your purpose in seeking these comparisons with other companies?
  • Who are you trying to convince and what are you trying to convince them to do?
  • What specific peer companies should be used for comparative purposes?
  • Are these companies (and their operations and exposures) truly similar enough for a fair comparison?

Beware Of Pitfalls
There are many hurdles to surmount in locating suitable companies for external benchmarking comparisons. Generally, when benchmarking comparisons can be made, more often than not the greatest value lies in the workers' comp line of insurance coverage.

Here are some key factors to consider when choosing contractors for external benchmarking comparisons:

  • Percent of self-performed work vs. subcontracted work
  • Payroll class codes and hazard groupings of selfperformed work
  • Differential geographic labor wage rates
  • Payroll rate variances between union and merit shop operations
  • Size of insurance deductibles
  • Claim reporting practices

For example, claim reporting practices must be similar in order to minimize distorting the frequency or average cost of a claim. If one or more comparison companies self-administers minor claims or does not report all claims to their carrier, using carrier loss reports for the comparison is an invalid method.

We also find that comparing the frequency of claims and total loss dollars divided by thousands or millions of dollars of payroll (exposure basis) is a helpful workers' comp benchmark between companies of similar operations in similar states.

Likewise, a suitable benchmark for auto liability performance compares the frequency of claims and total loss dollars per one hundred vehicles.

When benchmarking fleet-related claims, ensure that the number and size of fleet vehicles — as well as the type of driving (urban vs. rural) and the total number of miles driven annually — are similar among the contractors whose claims are being compared.

Benchmarking comparisons of Comprehensive General Liability insurance results are especially challenging due to delays in reporting third-party bodily injury and property damage claims, in addition to the expected long tail of loss development for these claims.

All of these factors are compounded by vastly different litigation trends and liability settlements in various states and regions of the country.

Common Limitations Of Data Sources
Whether or not you intend to develop a baseline of your company's claim data or to benchmark your company's performance against a peer company, there are several issues that must be successfully resolved regarding the data's quality and integrity.

Based on our experience, we classify the key challenges associated with exposure and claim/loss data into the categories shown in Exhibit 4: availability, accuracy, accessibility, standardization, reliability, comparability, and date-related problems.

Seven Data Challenges

Value Of Multiple Measures
Evaluating data from various sources and different angles is also valuable. Why? Because it's possible to gain a better understanding of the whole by dissecting the parts. This practice illustrates the principle of multiple measures.

This approach is substantiated by 2006 research, which concluded that the “simultaneous consideration” of frequency and severity provides a more comprehensive result than performing analysis based solely on one factor.1

This is similar to our approach when we conduct a “Claim to Exposure Analysis” and review historical frequency and severity vs. the relative bases of exposure for each line of casualty insurance coverage.

Returning to the health club analogy, when starting a formal exercise program, you often begin with such general baseline measurements as height and weight; this is usually followed by additional measurements, such as BMI, body fat content, and the girth of arms, legs, and chest (the baseline).

As we all know, weight alone is not always the best indicator of success in fitness efforts. In fact, since muscle weighs more than fat, an increase in total body weight may actually occur after beginning and maintaining a fitness program.

Although you might not experience a dramatic weight drop, you could see a reduction in waist size and BMI — positive changes that would not be evident unless multiple measures were being used and reviewed.

Benchmarking insurance claim and loss data performance is like comparing one person's height and weight against the ideal height and weight charts based on the entire population.

Wouldn't it be more effective to establish your baseline weight and other multiple measures initially so you can see the progress you are making?

This is similar to the baseline measurements that a company should take (as well as the multiple measures) that are necessary to meet your company's performance improvement goals for financial success, operational excellence, or risk reduction.

Web Resources:

  1. U.S. Department of Labor BLS Incidence Rate Calculator and Comparison Tool
  2. National Institute for Occupational Safety and Health Work-Related Injury Statistics Query System
  3. Risk and Insurance Management Society, Inc. Benchmark Survey
  4. Construction Industry Institute Benchmarking & Metrics
  5. National Council on Compensation Insurance, Inc. (NCCI Holdings, Inc.) Benchmarking Tools
  6. Employer Measures of Productivity, Absence and Quality EMPAQ
  7. CFMA's Construction Industry Annual Financial Survey with Benchmarking Builder CD

Authors
Cal Beyer collaborated with Greg Stefan in writing this article. Greg is Assistant Vice President, Construction Risk Control Solutions, at Arch Insurance Group. As a member of the Southeast Regional team in Atlanta, GA, Greg supports underwriting and claims in risk selection, claim mitigation, and risk improvement activities. He is also responsible for high-risk liability risk reduction initiatives including contractual risk transfer, construction defect prevention, and work zone liability management.

1 Baradan, Selim, and Usmen, Mumtaz A., “Comparative Injury and Fatality Risk Analysis of Building Trades,” Journal of Construction Engineering and Management, May 2006, pp. 533-539.

Construction Defects: A Primer For Construction Financial Managers

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

Industry Factors Company Factors Project Factors
Traditional split between design, engineering, and construction functions Type of company: GC vs. Specialty Trade contractor Multiple parties involved in construction (subcontractors, sub-tiers, and suppliers)
No uniform definition for quality or quality management Percentage of lump sum (hard bid) vs. negotiated work Design factors, especially the building envelope
Increasing number of fast-track projects Typical project delivery method used: Design/Bid/Build vs. Design/Build Tight scheduling and sequencing of trades and tasks
Historically thin profit margins that shift priorities away from quality Owner selection process and percentage of work for repeat owners Jobsite geotechnical factors: water table, drainage, and soil type
Conflicting definitions of what constitutes rework Commitment to a zero defects and management accountability culture No overall assigned responsibility for quality management at the project level
Long tail before latent construction defects manifest as completed operations claims Historical performance with liability insurance, especially completed operations claims for latent construction defects Third-party design review completed and course of construction conformance inspections scheduled
Contractual risk transfer of liability through indemnification and additional insured contract requirements Insurance program structure: deductible vs. guaranteed cost program, limits purchased, and premiums paid Weather (especially wind-driven rain) and climate factors (including differential thermal vapor transfer due to temperature, humidity, air flow, and ventilation)
Lack of uniform quality management metrics to establish performance baselines or benchmark comparisons Quality control and quality assurance staffing, programs, policies, procedures, and protocols Lack of uniform methods to measure or monitor quality performance during the course of construction
Lack of systematic method for allocating uninsured indirect costs of poor quality Failure to develop job costing method to capture and chargeback indirect costs of poor quality Indirect costs not captured and charged-back to project in job costing

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

Phase of Construction Leading Indicators or Metrics
Pre-Construction

Number of third-party expert reviews on building envelope designs and materials

Number of subcontractors with pre-approved quality programs

Number of projects with site-specific quality plans

Architect approval for changes to specified materials or design specifications

Course of Construction

Number of projects completed with zero punch list items open

Percent of documented moisture evaluations of incoming materials

Number of quality assurance inspections completed

Percent of discovered defects corrected

Percent of notifications on moisture, water intrusion, mold, or other key events

Post-Construction

Percent of completed project files with documented inspections and corrections

Percent of project turnover video training programs documented

Number of signed and certified receipt of turnover documents by owners

Scheduled follow-up inspection process with owners verifying no quality issues

Number of maintenance callbacks during warranty period

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

  • Vision and culture for zero defects, zero punch lists, and/or zero rework
  • Quality management organizational structure and staffing
  • Owner selection practices and risk-adjusted process for project approval
  • Prevention measures throughout the construction life cycle
  • Subcontractor prequalification and oversight process
  • Insurance and contractual risk transfer review
  • Conformance verification vs. nonconformance detection during course of construction
  • Project closeout and owner education processes
  • Warranty period and maintenance callback processes
  • Response and mitigation of known or suspected problems
  • Claim coordination and documentation for defense
  • Measurement and continuous process improvement
  • Management accountability systems that include quality measurement in personnel performance evaluations and decisions about bonuses
  • Quality awareness education and staff training

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

Consequences Primary Risk Secondary Risk
Decreased productivity due to required rework Operational Financial
Diminished profit margin (or loss) on project Financial Reputation
Delayed turnover of completed projects Operational Reputation
Loss of key clients due to dissatisfaction Reputation Financial
Possible liquidated damages from delayed completion Financial Legal
Higher deductibles, increased premiums, and/or lower limits for liability insurance Insurance Financial
Increased legal costs to defend against alleged construction defect claims Financial Insurance/Legal
Damaged partnerships between GCs and subcontractors Reputation Operational
Fewer opportunities to bid or negotiate for future work due to damaged reputation Financial Reputation
Type and size of projects limited for future work due to lowered surety bond credit line Financial Reputation
Surety bond default and company survival threatened due to decreased corporate profitability Financial Reputation

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.