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Adding Value through Risk Management – Part II

FMI’s Andrew Patron, Zurich’s Karen Schwartzkopf and Lockton’s Tom Miller talk about the importance of safety and becoming risk-aware.  (Click here to read Part I of this Q&A.)

Patron: Would it be fair to say that safety is at the top of the list of things we want to manage in terms of on-the-job risks?

Miller: I think safety is paramount, absolutely.

Schwartzkopf: I agree. In our industry, there’s an average of three fatalities a day, seven days a week. Safety must be at the top.

Patron: You mentioned some of the qualities of a good risk manager. What are the good companies doing to mitigate risk? What seems to be working in the industry?

Miller: Companies that embrace the Construction Industry Institute (CII) best practices for safety and focus on a zero-injury and zero-incident philosophy tend to vastly outperform the balance of the industry. I think in part that is due to their involvement in CII, together with an open mind to embrace different approaches to making each jobsite a safe environment.

Patron: Are you saying that companies that mitigate risk well are outperforming the ones that don’t?

Schwartzkopf: The company that manages risk is putting processes in place to help mitigate that risk.

Miller: While I think it is difficult to answer that question in the affirmative on a blanket balance sheet basis, it is certainly our opinion that, yes,  companies that manage risk well might outperform others over the course of time. As mentioned earlier, if you are a contractor and deliver the project in a timely manner, you avoid reputational risk. Also, if you are a contractor working for one of the large industrial or petrochemical organizations, either in the United States or globally, they will not accept a lack of focus on safety on their jobsites. They cannot afford it. When bad things happen on a project like that, these companies will not tolerate it. Several years ago, we had a client who was open-minded about managing risk and it was in trouble with one of its large industrial clients over safety issues in an extremely difficult work environment. We were able to provide it with some risk engineering insights and sent four risk engineers to its worksite for a six-week period. At the end of that period, we reported what our engineers had found and their recommendations for turning things around. Not only was our client not terminated, but in fact it was awarded additional work that previously had been awaeded to one of its competitors. This was because it chose to focus on the owner’s concern, which was, “What are you going to do about safety on my site?”

Schwartzkopf: When you think about it, ur most important asset is our human resources. A company is at reputational risk if it is not dedicated to safety, nor has a culture that promotes safety. Its ability to attract and retain talent is also impaired.

Patron: What are some of the things that risk engineers are looking for? Is it possible to effectively train or get people within organizations to become more risk-aware?

Miller: I for one would hesitate to answer on behalf of our risk engineers because I think their skill sets are far beyond my own in that regard. But to answer the other part of your question, yes, you can help make a better risk manager. Part of that is having the risk manager, or the account as a whole, partner up with a strong carrier or service provider that has solid in-house risk engineering expertise. Someone that they can call out to a site and say, “Hey, something’s out of kilter here; I need somebody with experience to come out and help me to see what you see.” For example, the risk engineer could show up to find an untidy site, which is often a precursor or symbol of a poorly managed site from both a schedule and a safety perspective.

Schwartzkopf: One of the services that our risk engineering team provides is a cultural assessment survey called Zurich X-Ray. It is an interview-based assessment program that assists contractors in distinguishing areas of corporate culture, management and communication that affect their operations. It looks at communication practices throughout the organization from top to bottom. The program measures the difference between management expectations and field perceptions and provides practical solutions with the ultimate goal of helping achieve operation excellence. If there are gaps between what mid-management and craftworkers believe about the culture of the organization, or between craftworkers and senior management, there are opportunities to develop consistency in the culture of the organization. That can make a significant change in the way a company is managed, as well as in loss results.

Patron: Is the industry doing an adequate job of managing risk?

Schwartzkopf: I think there is always room for improvement.

Miller: I would agree with that.

Schwartzkopf: We still have people who do not go home at the end of each day; they are one of the fatalities. There is room for improvement there. There is room for improvement with quality. There is room for improvement when we look at things like Chinese drywall and how companies are managing their supply chain.

Patron: With that in mind, how does risk affect the industry as a whole?

Schwartzkopf: Very simply, risk affects us all the same way. It creates uncertainty. If we could try something new without having to worry about risk or loss, decisions would be much easier for all of us. We think about our clients and whether they are managing risk differently post-recession versus pre-recession. With the construction economy as it is, some contractors are chasing work in a different way today that brings about different risks. We see a number of clients moving into federal work and do not see all of them managing the risk associated with that work. Do they understand the FAR and CAS requirements and preparing for additional exposure? If you are not aware of the risk and are not managing for the risk and potential loss associated with federal work, it can cost you in the end and could cut or squeeze your profits even more.

Miller When there is no alignment between the party accepting the risk and its ability to control, influence or bear the cost of that risk, then I think the easy answer is that you might end up with higher overall project costs, whether you are the contractor or the owner. If you force the risk onto the contractor and the contractor feels it is not in a position to influence that risk and the risk could be a significant exposure to its balance sheet, then the contractor can tackle that via a contingency. If this is an inappropriate contingency taken by the winning contractor, the result will be a higher project cost.

Patron: So both sides will lose.

Miller: Well, one side could gain and one side could lose (it would be a zero-sum equation in that regard), or both sides could lose. The contractor might be awarded the project with a more than adequate contingency and thereby earn additional profit on the job with the owner paying more for the project. Or the contractor might plug in a contingency that is inappropriate for the risk and does not win the job. The owner then turns to somebody who is willing to accept that risk with no contingency and finds itself with a contractor that is unable to complete the project, in which case it finds itself in litigation or arbitration, and that is rarely a winning situation for anyone.

Patron: If a company wants to differentiate itself, what would it need to do to get really good at risk management?

Miller: I think the first place to start is with the company’s senior management. It has to define what it is going to be. Is it going to be “betting the house” on projects, or is it going to take the time to essentially underwrite its clients the way we would underwrite a contractor for insurance purposes? What is the client’s reputation? What is the client’s ability to pay for the project? There is a risk of payment inherent to the contracting process. How does it select its subcontractors? Does it have appropriate prequalification procedures in place for subcontractors? Does it have appropriate quality controls? It is really setting aside the time and resources to perform a project the right way the first time versus assuming some measure of rework or lost-time injuries as a given. Management needs to be committed to focusing on eliminating those rework and lost-time issues on the front end.

Schwartzkopf: Tom, I think you bring up a great point that it has to be senior management’s commitment to making good risk management the culture of the organization. From a blocking and tackling perspective, I think it is just practice. We see some risk managers in broad enterprise risk management roles who surround themselves with good advisers and a good team. They are knowledge seekers. Earlier we talked about the qualities of a good risk manager; a healthy imagination doesn’t hurt either. Make sure you’re thinking through all of the what-ifs and identifying what those risks are so there are no surprises. In addition, there are some great peer groups. There is an E&C peer group that convenes to discuss risk and risk management strategies. There is data available from the CII that focuses on best practices in managing risks, and then of course there is expertise from your carrier and broker.

Patron: Do all unmanaged risks show up on the bottom line of the financial statement?

Miller: Well, in insurance, I never discount the element of fortuity that the risk might not manifest itself on any particular project, but over the course of  time ignoring risk does not make it go away. It simply means that you have not recognized it and set aside the appropriate resources to manage it. In short, the risk may not impact the bottom line on any particular project, but it will over the course of time on a portfolio of projects.

Schwartzkopf: Two of the basic tenets of risk management are do not risk more than you can afford to lose and do not risk a lot to save a little. The worst kind of risk that you can retain is the one you did not know you had.

Reprinted with permission from FMI Corporation. For more information, call (919) 787.8400 or visit http://www.fminet.com. Part III of this Q&A will discuss coverages, managing the unexpected and the value of risk management.

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