Construction Risk Management Guide
There’s no doubt that construction is a risky business. The
list of risks facing contractors is a long one: worksite injuries, skilled
labor shortages, cash-flow problems, contract disputes, job-site theft, defects
in workmanship and material, weather delays and supply interruptions, to name just
a few.
Understanding the risks construction firms face can help you
better assess your own risks and create strategies to reduce them.
Risk evaluation and mitigation can lead to reduced costs and
a more controlled project schedule.
Intense competition for projects, low margins and profits,
safety issues, and the potential for disputes and litigation are just a few of
the challenges that contractors live with daily. That’s why risk management
should be an essential component of your planning and day-to-day operations.
Risk management planning can be the hardest part of a job
because it takes a lot of time, thought and people. Many projects (construction
or otherwise) fail due to a lack of planning and clear communication rather
than because of people or processes. The time spent on creating a clear and
well-communicated plan before landing on a worksite will pay off quickly.
A risk management strategy can yield several significant
benefits, including the following:
Increased efficiency
By incorporating a solid risk management strategy into all
your projects, your jobs will go more smoothly with fewer delays and cost
overruns. Once you have a template developed, you canapply it to future
projects and make improvements over time.
Improved safety
Assessing the safety of each job site, checking the
condition of heavy equipment, properly maintaining tools and machinery,
requiring workers to wear the appropriate personal protective equipment (PPE),
providing training, conducting frequent toolbox talks, investigating all
near-misses and having a proactive safety plan can protect against unnecessary
injury, insurance claims and costly litigation.
Reduced claims
Workers’ compensation insurance is a big spend for most
construction companies. Safety training and risk management strategies can help
to keep high experience modifier ratings under control. A formal training
strategy may be helpful as proof of good-faith efforts to maintain a safe
workplace and reduce hazards.
Potentially lower insurance rates
Workers’ compensation insurance rates may drop if your
experience modifier rating is lower than the standard, but you may be viewed as
a better risk by insurance companies if you can show proof of your written risk
management plan, as well as certifications and training records of your crew.
At the very least, keep in mind these six components:
1. Budgets and cash flow. Are you monitoring your
construction budgets and cash flow?
2. Construction law. Are you reviewing contracts,
complying with building codes, obtaining needed licenses and permits, and
complying with safety and labor rules and regulations?
3. Planning. Are you using the latest programs and
software (and are you well versed in their use) to schedule work, allocate
resources and streamline your workflow?
4. Procurement. Are you purchasing supplies and
material that meet quality specifications at a competitive price?
5. Quality management. Do you have a quality control
plan in place to meet quality-assurance standards?
6. Risk management. Do you have a written risk
management plan?
Risk categories
When identifying and analyzing risk, it’s helpful to see how
risks can fit into categories. Here are some you should consider as you begin
to identify your own project risks:
● Technical risks such as poor design, insufficient
site investigation, inadequate specifications or the unavailability of
specified materials
● Logistical risks such as the lack of proper
equipment, sufficient spare parts, fuel, labor and transportation
● Construction risks such as uncertainty of supplies,
worksite injuries and accidents, negligence, construction defects and weather
or seasonal uncertainty
● Contractual risks such as legal or regulatory
issues and contract and labor disputes
● Financial risks such as cost escalation, delays in
payment, rising interest rates, lack of sales or unmanaged growth
● Project risks such as lack of proper management,
inadequate allocation of resources, and unrealistic schedules or schedule
changes
● Political risks such as zoning disputes, lack of
funding for a public project or political unrest
● Competitive risks such as pressure to underbid a
competitor, lack of profitability and being overextended
● Ethical risk such as pressure to engage in
political games or win bids using questionable tactics that could put current
and future contract engagements at risk
Conducting a Risk Management Analysis
Identify and list risk areas
Risk assessment and mitigation
Identifying risk areas and their impact on your business
Risk/likelihood matrix
Risk responses
Construction Defect Risk
Types of defects
Taking steps to eliminate defects
Equipment Risk
Steps to avoid equipment theft
Insurance – equipment considerations
Insuring equipment and other transportation issues
Disasters and Emergencies to name a few
Fires
Flooding and hurricanes
The Need for Additional Insurance
Business interruption
Catastrophe or weather endorsements
Pollution/environment
Professional liability/errors and omissions (E&O)
Identify and list risk areas
Begin your analysis by listing the hazards or threats you
are most likely to encounter. Common construction risks include:
● Accidents to workers or the public
● Damage to property
● Loss of time and production
● Loss of key employees, skills and experience
● Loss of reputation and future projects
Be sure to consider these areas:
● Staff and labor. What if your project manager left?
What if you lost a key subcontractor? Do you have enough skilled labor?
● IT and communications. How vulnerable are your
devices to cyber attacks? How often do you back up systems?
● Job site. How prepared are you for accidents and
weather events? Environmental hazards?
● Materials and supplies. What if you lost a key
supplier or prices went up? Do you have other suppliers who are able to meet
your prices and specifications?
● Equipment. What is the impact of losing needed
equipment and tools to theft or damage? How quickly can you replace them?
Controlling Risk
Once you have measured the impact of a risk on your project,
you must create a strategy for controlling the risk. Consider:
● Labor you must hire
● Equipment you need
● Technology that needs to be in place
● Information that must be available
● Subcontractors, suppliers and vendors you will rely on
Most common injuries in construction:
Here are some top risks to keep in mind:
● Falls. Perils include scaffolding, ladders, roofs, cranes
and other equipment.
● Falling objects. These include tools and material among
other objects.
● Electric shock and arc flash/arc blast. Damaged and worn
electrical cords, equipment too close to power sources or power lines, and
improperly grounded electrical tools are some of the causes of electric shock
and arc flashes.
● Equipment accidents. Forklifts, cranes, backhoes, nail
guns, ladders and scaffolding are common sources of accidents.
● Vehicle accidents. Being hit or run over by a truck
backing up or being caught between two vehicles are common accidents.
● Trench collapse. Entering unprotected trenches and failure
to use protective systems such as sloping, shoring and shielding have led to
injuries and deaths.
● Repetitive motion injuries. Workers can develop
musculoskeletal injuries from doing the same workday after day.
● Weather-related illnesses. Workers can suffer from
weather-related hazards such as heat illness, hypothermia or frostbite.
Bonds
Insist that primary and specialty subcontractors be bonded.
Surety companies, which issue performance and payment bonds,
can be an invaluable resource
because they require contractors to undergo a rigorous
prequalification process.
Construction Defect Risk
Construction defects range from sloppy workmanship to
serious design flaws that could jeopardize the integrity of a structure.
Unfortunately, defects are part of the building process, and general
contractors must take steps to document defects so they can be rectified.
Types of defects
Defects fall into four basic categories, and there can be
legal and financial consequences for each one.
1. Design deficiencies arise when an architect or engineer
designs a structure that doesn’t function as intended. A design may be outside
the code. Or a design intended for one type of project may be used for another
without proper modifications.
2. Construction deficiencies are essentially poor
workmanship. These deficiencies can result in a host of defects ranging from
water intrusion (leading to dry rot and mold) to electrical, HVAC and plumbing
problems.
3. Product and material deficiencies can cause serious
problems. Any number of materials can have defects, including asphalt shingles,
drywall, particleboard, waterproofing membranes and exterior coverings.
4. Subsurface deficiencies include improperly compacted soil
and expanding soil, which can cause major problems with settling and shifting.
It is especially important that the soil be properly prepared and that there be
adequate drainage.
Taking steps to eliminate defects
While you can’t eliminate defects completely, you can reduce
their likelihood.
·
Make clear the design and construction standards
you expect your workers to follow.
·
Monitor work on the site, conduct inspections
and test to identify and correct any Defects
·
Always keep detailed records of work, including
photos, and test and inspection results.
·
Consider having an independent third party
review the work and ensure that it is free from patent defects.
As the project winds down, keep a detailed list of those
items that have not yet been completed and hold your subcontractors to
finishing them.
Contractual Risk
General conditions
As a contractor, many of your rights and responsibilities
are spelled out in the general conditions of the contract. Note, too, that
owners have been transferring more risk to their contractors, a trend that your
team needs to be aware of.
Your risk management team should be familiar with these
conditions and the risks associated with them. You should be familiar with all
provisions of your contract, such as obligations, deadlines, payment, risk,
insurance, hold harmless, subrogation and others.
When in doubt – reach out. Ask an attorney for legal advice
or to review any questions about your contracts before signing them. Pay
attention to conditions listed in all your contracts and always understand the
meaning of the sections such as the ones listed here.
Scope of work
Make sure the contract clearly spells out your duties and
obligations, including complying with project plans, specifications and
building codes.
Time-is-of-the-essence clause
Understand the deadlines in the contract for you to complete
work and the penalties if you donot comply, including liquidated damages and
breach of contract.
Payment terms
Many disputes arise from disagreements about payment. Make
sure you include a payment schedule and understand what progress must be made
to receive payment.
No damage for delay clause
Understand your rights when an owner or subcontractor delays
the project.
Indemnity clause
With more risk shifting to contractors, be aware of the
circumstances under which you are\ indemnified. Typically, the contractor
assumes the owner’s liability for losses on a project depending on how broad
the indemnity clause is.
Contract disputes and common causes for them
Contract disputes are the leading cause of legal issues for
construction firms.
Top reasons cited by the report for disputes include
contractual errors and omissions, poor contract administration and contractual
misunderstandings, and others such as:
● Quality of construction – substandard work and
construction defects
● Failure to use specified materials – substitutions of
lower-quality material
● Delay in construction – work not completed in a timely
fashion
● Abandonment – walking away from the job
● Nonpayment – failure to pay on time
While no one wants to go to court, contractors often find
themselves the subject of lawsuits. Prepare your staff and project managers for
the possibility of claims and litigation.
● Educate your employees on the terms of each contract and
on how to maintain adequate records, properly document change orders, obtain
necessary permits and comply with building codes.
Cash Management Risk – Red Flags
Construction is a capital-intensive business and it’s easy
for contractors to become overleveraged. You may have working capital tied up
in multiple projects. Likely you’ve sunk a lot of money into equipment and
tools. Maybe you’ve underbid a project or fallen behind in billing. Or perhaps
you underestimated your costs. As a result, you may be experiencing cash-flow
problems.
Here are a few things to watch out for and to attempt to
remedy when experience cash management risks:
Profit fade
Are your profits holding up over the course of a project? If
they’re fading, what’s causing it?Profits generate income on your balance
sheet, so falling profits can erode your capital.
Underbilling
Work completed that hasn’t been billed for is a red flag and
can hurt your cash flow. Always have a schedule for when you will invoice and
be paid. Don’t perform work without a contractor change order, especially if
it’s not clear whether the owner will pay for it.
Cost backlog
How much of a backlog do you have, and what is the total
cost of completing those jobs? For example, if you are bidding on a 10 Crore job
and already have a 30 Crore backlog, you maybe overextended.
Liquidated damages
Have you given yourself enough time to finish the job? If
the job runs over, what will be the cost of liquidated damages?
Borrowing
How much debt does your company have? Overreliance on
borrowing can affect your financial condition and reduce your cash flow.
Change orders
Manage your change orders so they don’t add to your costs.
Poorly handled change orders can lead to delays and disputes, especially if
they are caused by a poor design or errors and omissions.
Use project management best practices as a guide to help you
mitigate the risk of becoming overleveraged.
Equipment Risk
Equipment and tools may well be your firm’s largest capital
investment. Proper maintenance, safe operation and secure storage of these
assets should be of primary concern to your risk management team. The loss of
expensive equipment and tools can cause severe financial hardship and even
bankruptcy.
Steps to avoid equipment theft
You should have a process for inventorying, securing and
tracking your equipment. Here are a few things to consider:
·
Secure your job site with a chain-link fence.
·
Make sure the site is well lit and easily seen
from the road.
·
Install security systems such as alarms, motion
detectors and surveillance cameras.
·
Consider installing GPS tracking devices or
telematics on your heavy equipment so you can track movement in real time and
recover stolen items.
·
Install theft deterrents such as fuel shut-offs,
alarms, electronic keys, ignition disablers and wheel locks.
·
Remove keys and fuses when equipment is not in
use, especially in smaller more mobile pieces of equipment If you can easily
drive it off the lot, it is a bigger target.
·
Inventory your equipment and record details such
as make, model, purchase date and serial number. Take photos, keep receipts and
all documentation of your equipment and store them in a safe location.
·
Stamp or engrave equipment and parts with
identifying marks or your company name and logo.
·
Maintain an Equipment Register.
·
Train your operators on site protocol such as
shut-off, locking, parking and logging their use of equipment.
Insurance – equipment considerations
Make sure your equipment is insured and you are aware of any
limitations or exclusions that you will need to self-insure. Also make sure
you’ve taken the time to keep your insurance professional updated on the types
of equipment you’re using on the job. Review your policy with them so there are
no surprises for either of you, such as:
Is your equipment listed on your insurance policy?
Do you have the proper amounts of coverage for each piece of
equipment declared in your policy?
How will your equipment be valued if a loss occurs?
Will it be at replacement value, actual cash value or agreed
upon value?
Have you updated your insurance professional on the types of
work you’re doing, equipment involved as well as the location?
Have you expanded or shrunk your inventory or business
scope?
Insuring equipment and other transportation issues
Equipment is essential to your operations and the difference
between getting the job done or missing out. Proper equipment insurance is part
of your overall risk management plan. Here are a few equipment and auto-based
insurance coverages to talk to your insurance professional about.
Inland marine insurance
Heavy equipment needs to be transported to and from
worksites and is in storage when not in use. Commercial property insurance
covers property only at the locations listed on the policy.
That’s why contractors need inland marine insurance, which
covers the insured property no matter where it is located.
These policies typically cover products, tools, and
equipment that are in transit over land or stored at an off-site location. They
may cover property inside a commercial truck or movable property in a fixed
location. Often, they are added by endorsement to an existing policy, such as a
business owners policy (BOP) or commercial general liability (CGL) insurance.
Ocean marine insurance
Like inland marine, ocean marine covers equipment that is
being transported over bodies of water.
If you are or will be involved in projects that involve equipment transport
over water, talk to your insurance professional.
Contractor tools and equipment insurance
Make sure you’re clear on how the equipment is valued if
stolen such as actual cash value, agreed upon value or replacement value.
Leased equipment insurance
If you need to rent equipment, you will likely be asked by
the rental company to show proof of insurance (a certificate of insurance) and
to name the rental company as an additional insured.
This can be accomplished by including an Additional Insured
– Lessor of Leased Equipment form in your liability policy. Speak to your
insurance professional to add this endorsement.
Loaned equipment insurance
Borrowing equipment is common on a job site. One
subcontractor may ask another if they can borrow a tool or piece of equipment.
Generally, borrowers are expected to pay for a damaged item, but their
liability policy may need an endorsement for borrowed equipment.
Mobile equipment insurance
It usually depends on whether the equipment is self-propelled
and can be driven on public roads. Check with your insurance professional to
see which type of policy you need to cover liability and physical damage.
Commercial auto insurance
Commercial vehicles such as pickup trucks and vans should be
insured. Business auto insurance policies cover medical bills and property
damage from an accident, vehicle theft and other damage. Your insurance
professional can discuss coverage, deductibles, limits and exclusions.
Follow cyber best practices
Consider implementing these best practices in your business:
·
Use strong passwords and two-factor
authentication. Create a unique password for each of your accounts and change
passwords regularly. Use two-factor authentication to augment your passwords.
·
Install antivirus software on devices and keep
it updated. Download software updates and security patches so your computers
and devices are current.
·
Limit who has access to information and ensure
that user accounts are updated as soon as employees leave your organization or
change their job roles.
·
Train your employees on the types of suspicious
activity to look for such as malware, social engineering attacks, phishing
scams, spear-phishing and ransom attacks (denial of service). Train them on how
ow to protect their computers and network systems from intruders.
·
Lock and secure your networks just as you do
your premises. Segregate your less important systems or smart appliances to a
different subnetwork so they can’t be used to exploit your key network
infrastructure.
·
Back up data on a regular basis. Train your
staff to backup files daily and to store the backup devices in a secure
location.
Protect your mobile devices and media. Encrypt confidential
data on smartphones, laptops and flash drives, or other devices that could be
lost or stolen. Do not exchange sensitive information over public Wi-Fi. Do not
download any unknown media into your devices.
Talk to your insurance professional about getting a cyber
insurance policy quote. A general liability
policy will not adequately cover the various responses needed if you experience
a data breach.
You may need to review your insurance coverage for data
protection and cybersecurity. Ask your insurance professional about data breach
and cyber liability insurance to cover the cost of a breach and other cyber
risks.
Disasters and Emergencies
All organizations should have a plan for responding to a
natural disaster or workplace emergency. Prepare for these contingencies as
part of your risk management plan. Here are some common incidents you should
keep in mind:
Fires
Fires are common in construction work. You may already have
a separate fire safety plan, a document that covers all aspects of fire
prevention and protection at the job site. Such plans generally include a safe
and orderly way to evacuate the premises, procedures to prevent firesand
methods of control that minimize the damage of a fire if it occurs.
Flooding and hurricanes
These natural disasters can be slow-moving, powerful and
deadly. Strong winds and rain can continue for many days contributing to
widespread flooding and restricted access.
The best course of action is to evacuate before flooding
starts.
Follow the directions from local officials for community
evacuation or seek high ground for localized flooding.
Testing your response plan
Regularly test the various systems that your plan relies on,
including:
● Emergency notification systems
● Fire alarms, sprinklers and fire extinguishers
● Fire escapes, evacuation routes and lighting
● Network firewalls
● Computer backup systems
● Generators
Reducing Risk Through Surety Bonds
Surety bonds are one solution to the risks associated with
finishing a construction project. A surety bond is a three-way contract between
the surety company , the contractor (the principal) and the project owner.
In essence, the bond is a promise on the part of the surety
to be liable for the debt, default or failure of the principal. The surety must
make good on the principal’s contracted obligation to the obligee.
The surety company is required to step in if there is a
default to make sure the project is completed, and suppliers and subcontractors
are paid. Sureties often accomplish this by hiring another contractor or, in
some cases, providing financial assistance to the original contractor so it can
finish the job.
Types of surety bonds
Contract surety bonds are generally divided into a few
types.
● A bid bond assures that the contractor intends to enter
into the contract at the price bid and will provide the required performance
and payment bonds. The bid bond is the basic instrument of prequalification,
which means the surety has investigated the contractor’s entire business
operations and deems it qualified to perform the contract.
● The performance bond is a binding obligation of the
contractor and surety for the performance of the contract or payment of the
cost of performance, up to the amount of the bond. It protects the obligee from
financial loss should the contractor fail to perform the contract in accordance
with its terms and conditions.
● The payment bond assures that certain subcontractors,
laborers, and material suppliers will be paid in the event of contractor
default.
● The maintenance bond provides assurance that the
contractor will complete any maintenance required by agreement after the work
is completed.
The Need for Few Other Additional Insurances
Business interruption
Also known as business income insurance, these policies
cover the loss of income after a disaster, whether it’s due to the closing of
your business or the rebuilding process after the disaster. They’re designed to
put your business in the same financial position it would have been in if no
loss had occurred. They’re usually offered as a rider or endorsement to a commercial
property policy or a business owners policy.
Professional liability/errors and omissions (E&O)
If your firm provides professional advice or services such
as engineering or building planning, chances are you have some type of
professional liability insurance to protect against lawsuits. If not, ask your
insurance professional about the various policies available.
Fidelity bonds or crime insurance
Fidelity bonds, sometimes called crime insurance, protect an
employer against employee dishonesty. Most policies cover theft and
embezzlement, computer fraud, illegal fund transfers, counterfeiting and other
dishonest acts.
Key person insurance
This is a form of life insurance that partners or key
employees in a business take out on each other. It’s used for succession
planning and can help to cover expenses during the transition after a key
person dies.
Workers’ compensation
States legally require that workers’ compensation insurance
for any employees, whether full or part time. It is further complicated if you
have multistate locations. Gig economy workers can pose a liability as well.
Just because they are not employed by you, doesn’t mean that a lawsuit isn’t
possible. Talk to your insurance agent about your state laws.
Builder’s risk and installation
You need insurance to cover the materials and tools stored on-site (to complete the structure) as well as the structure itself. Talk to your professional about the types of construction projects you’re involved in and find out who s
