Risk management in the construction industry involves a set of issues, conditions and variables with a complexity that few other industries can match. Economic downturns, bad weather, and the cost of labor and materials all play into the success or failure of a company.
To identify and track what construction companies consider a threat, the “Sterling Risk Sentiment Index” twice-yearly survey of construction professionals offers clarity about how construction professionals view the industry’s trajectory.
The latest iteration of the index is providing a snapshot of where the construction industry is headed in 2016. Construction companies grew more optimistic about their risk exposure at the end of 2015. Their “risk sentiment” dropped to a 4.4 (on a scale of 1 to 10), down from 5.2 in Q1 2015. It also shows that while profit margins continue to improve, companies are more concerned than ever about staffing, with access to adequate numbers of employees deepening its hold as the number one risk to businesses.
Because of a positive economic cycle, it is currently a buyer’s market for insurance. A year ago, 55 percent of respondents felt their risk was lower than a year ago; now, 71 percent do. Armed with the risk sentiment index numbers, here are some concrete actions that can be taken now.
- As part of reassessing risk strategy–and in light of today’s more optimistic construction environment–it’s a great time to negotiate hard on insurance conditions. This is particularly true if a company has had a good run the last few years, including low casualty losses. The market is particularly buyer-friendly right now. Some carriers are allowing clients to lock in a two- or even three-year rate commitment under certain circumstances.
- It’s telling that the concern regarding staffing continues to rise, from 44 percent in the first quarter to 60 percent in the fourth. It is not just a concern about numbers of unskilled workers, but also about a “tightness” in the skilled labor market, including labor being hired through subcontractors. Most subcontractors are stretched pretty thin right now, so it is vital to drill down into concentration risk (having too many jobs with a given subcontractor). Maintain efforts to keep the subcontractor base broad and deep. This takes effort on the part of the preconstruction staff. Continuing to be over-reliant on the same subcontractors “that have been used for years” can be problematic if one or more of them encounters financial stress during a boom time, especially in particularly hot markets like multifamily construction.
- Conversely, signing on with an unfamiliar subcontractor could end up costing if the work is not up to standards. Developing relationships with multiple subcontractors and thereby diversifying risk is a smart move. Moreover, subcontractor prequalification programs need to be tuned up and utilized fully. Risk management strategies such as subcontractor bonding and Subcontractor Default Insurance should be continued or implemented.
- The old saying about one person’s loss being another’s gain is playing out in the industry’s favor at the moment. As oil prices fall, commodities become cheaper, potentially reducing financial risk on projects. Jobs lost from the contraction in the oil and gas markets may help alleviate the labor stress in the construction industry as some of those skill sets are transferable. As those oil jobs become less viable, the industry may have an opportunity to capitalize on some manpower returning to construction’s labor force.
The industry has recovered greatly from the downturn, bringing new possibilities as construction continues to rebound. Remember that with new opportunity comes new risk. Be careful not to become over-invested in a booming niche market. Take advantage of a new set of circumstances, but be mindful that an overconcentration in a sector that suddenly contracts due to oversupply has risk. Where possible, seek to diversify the backlog across market segments so that when the inevitable slowdown occurs, the company has a varied portfolio.
Highlights from the Sterling Risk Sentiment Index include:
- The number one risk issue is overwhelmingly staffing, with construction companies struggling to have enough employees to handle projects. Sixty percent choose this, up from 44 percent. Economic issues ranked a distant second at 20 percent.
- Staffing again was the issue companies reported they felt least prepared to deal with right now (35 percent). Health care costs were next (16 percent), followed by computer hacking (14 percent).
- Seventy-one percent say their company’s exposure for risk is lower than a year ago, a substantial improvement over February’s 55 percent.
- Seventy-four percent of respondents say they have formal strategies in place to manage their risk, slightly down from 78 percent in February. Half say they don’t have those strategies clearly written down.
- Seventy-two percent have reviewed their risk management plans in the last 12 months, up from 69 percent.