Talk to people in the insurance business and you’ll hear them explain today’s skyrocketing rates as bouncing back from a decade and a half of premium decay. In this case, the bounce resembles what you might get from a trampoline, thanks to the Sept. 11 terrorist attacks.
Insurance is a notoriously cyclical business with wild swings between a buyers and sellers market. Though it may not have felt like it, construction contractors were in an exceptionally long buyers market from about 1985 until the last couple of years. Rates were on an upward swing even before Sept. 11, especially for workers compensation and general business liability coverage, simply because losses were rising.
For instance, the National Council on Compensation Insurance calculated that in 2000, workers compensation insurers paid out $1.21 in claims and expenses for every premium dollar taken in. Premium rates had dropped overall by 39 percent between 1994 and 1999 before starting to increase in 2000. (NCCI’s data covers the insurance industry as a whole; I doubt that workers comp costs dropped that much for construction firms.)
For a while, the rising cost of claims had been offset by a steady decline in the number of claims per worker. But this is said to be slowing, while medical care and various other costs are increasing. Moreover, workers comp coverage has been extended by law in various states to the point where an estimated nine out of 10 people in today’s work force are protected by workers comp insurance. Construction work, being among the most dangerous, gets hit proportionately harder than other industries.
Costs Up, Income DownSome insurance industry data needs to be taken with a grain of salt. For instance, even in good times it’s not unusual for insurance companies to pay out more than they take in from premium payments. The insurance business is structured so that profit dollars stem mainly from investment income. However, that has also hit the skids with the sagging stock market and interest rates.
You don’t need to have a PhD in economics to understand what happens when costs go up and income down. The terrorist attacks put this trend into hyper-drive as insurers faced claims that could run as high as $60 billion. By comparison, the previous largest insurance loss in U.S. history, Hurricane Andrew, resulted in $16 billion in claims. Insurers are spooked not only by the direct losses stemming from the devastated buildings and casualties, but the anticipated cost of rebuilding lower Manhattan, and nightmarish future liabilities if and when al Qaeda strikes again.
This may not seem to have much to do with your little contracting firm, but the nature of the beast is such that everyone pays when the insurance industry as a whole is in distress. In construction, subcontractors are being hit harder than GCs and building owners, simply because those folks have spent years honing their skills in transferring risk downward. General contractors in many cases are little more than labor brokers, employing hardly any work force of their own. Construction managers have also become more prevalent over the years on large commercial-industrial projects. Moreover, incremental costs for insurance coverage tend to be less troublesome to a large firm than to the smallish companies that dominate the specialty trades.
Insurance renewal increases on the order of 10 to 30 percent are becoming the routine, even for companies with good safety records. Those with a track record of significant losses are being hit with 50 to 60 to 70-percent increases, sometimes even more, for workers comp and general liability coverage.
Looking InwardSubcontractors are hardly blameless for the current set of circumstances. Too many specialty contractors continue to turn a blind eye toward safety training and practices that could do much to lower a company’s insurance risk — as well as save considerable grief among your workers. As long as premium costs remain affordable, many contractors adhere to a mindset that it’s cheaper to pay the rates than diminish productivity with safety programs.
This attitude is as shortsighted as it is cruel. The insurance rates you pay for workers comp, often the most expensive coverage, are determined largely by your Expense Modification Ratio. EMR is an insurance industry number that determines your degree of risk compared with other firms in the same type of business. An EMR of 1.0 is the industry average. Anything below 1.0 is good, above it, worse than average. For example, take a sizable job with a contract value of $500,000 and your labor costs are 30 percent of the bid, or $150,000. Now let’s assume an insurance exposure rate of $15 per every $100 of payroll, or 0.15.
The insurance cost for that job, based on the formula,
EMR x Payroll x Exposure Rate = Insurance Cost, would be as follows:
EMR of 0.8 = Insurance cost of $18,000
EMR 1.0 = $22,500
EMR 1.1 = $24,750
EMR 1.5 = $33,750
Keep in mind that the average construction job results in about 2 percent net profit, or $10,000 on a $500,000 project. As you can see, the difference between an expense modifier of 0.8 and one just slightly worse than average (1.1) is $6,750, which would wipe out two-thirds of the typical job profit. A dreadful EMR of 1.5 would likely result in a loss for the job in question.
Even more to the point, larger and more lucrative projects often exclude contractors with poor safety records from even bidding on the work. That’s because owners and GCs — who themselves are squeezed to the max and attempt to pass along their grief — have learned that safety pays in the long run.
Surety ProblemsToday’s insurance dilemma has also impacted the surety industry. Those of you who work bonded projects no doubt have been paying higher bond premiums, and maybe have run into certain situations where surety was hard to come by. According to Marsh Inc., the world’s largest construction insurance broker, surely loss ratios are above 40 percent for the first time since 1988, and a surety firm will tend not to be profitable with a loss ratio greater than 40 percent. Some of the largest surety companies have either gone out of business or suffered dramatic losses in the last few years. “There will not be a settling of the market until late 2002 at the earliest,” said a Marsh spokesman.
Roofing’s Dubious Distinction“The occupational injury and illness rate for roofing contractors is more than double the average rate for all private industry and is higher than any (in the) construction industry,” says an underwriting guide put out by the Insurance Information Institute (III). “In general, roofing work is considered even more hazardous than coal mining.” An astounding one out of five workers will suffer injuries and illnesses in the course of a year, reports the III.
The lengthy guide goes on to explain various reasons why this is so, which will come as no great revelation to those of you in the business — i.e., sloped roofs, heavy tools and equipment, hot and toxic materials, exposure to power lines and so on. All of these are an unavoidable consequence of the work itself.
What should command the greatest attention of roofing contractors, however, is III’s statement: “Lack of experience and formal training is the greatest cause of injury in the roofing industry. Most roofing accidents happen to workers with fewer than three years experience, and many injuries occur to roofers in their first month of employment.”
The III tells underwriters to ask some basic questions of roofing contractors: “Does the insured require all workers, regardless of experience or prospective tenure, to complete a safety awareness program? Are full-time employees required to take refresher training at least once every three years? Who is responsible for administering this program, and what are that person’s qualifications?"
Good questions for insurers to ask. And good questions for all of you to ask yourself even before they get around to it.