Controlling Your Workers' Compensation Cost through Risk Management

By Griff Griffith, CIC, CRM, CPA, Principal, GMGS Risk Management & Insurance Services

After benefiting from several years of post reform reduced premiums, California business owners are now being battered by a storm of rapidly rising workers’ compensation rates.  On top of a 37% rate increase effective January 1, 2012, Insurance Commissioner Dave Jones recently approved an additional 8% mid-year rate increase, effective July 1, 2012.  Certainly this 45% increase in workers’ compensation could not come at a more difficult time for many business owners as we continue fighting to survive one the most difficult economic times this country has ever known.  With such rate increases and painful economic challenges, how can companies survive such turbulent times?  Is there a proven solution to help companies rein in costs and increase productivity to stay competitive? 

Fortunately, such drastic rate increases are not a reality for all business owners.  A small population of companies has discovered that by utilizing a Risk Manager, as opposed to a traditional Insurance Broker, their company is better protected and even prepared for the work comp tsunamis we are currently facing.  Traditionally, the term risk manager has been associated only with large corporations that can afford to employ an in-house risk management professional.  Fortunately, this is no longer the case, as an outside risk manager can act as the “outsourced” risk manager for a wide range of mid-sized companies.  These risk managers work in tandem with business owners and the insurance companies to provide a distinct approach to achieving a company’s risk management goals.

The fact is upgrading to a risk manager brings about significant cost savings because of cost reductions in claims and insurance premiums.  Such a proposition seems like a no brainer, but how does a company identify a risk manager from an insurance broker? 

Brokers vs. Risk Managers

Risk managers perform many of the same duties as traditional insurance brokers, but it is their additional services and technical strategies that differentiate them.  Most insurance brokers will, at a minimum, approach multiple insurance companies and place coverages on behalf of a business.  Some quality brokers use this marketing process to ensure the business is well insured at a fair price.  The proactive broker may also provide additional service, such as limited claims management.  However, if it were possible to secure an even higher level of service above & beyond that of a proactive broker, with no increased cost, would it be of interest?

While Risk Managers provide traditional broker services, including the marketing and placing insurance coverage, their risk management services extend far beyond the services of a traditional broker.  The focus of an interactive risk manager is to provide proper risk protection while also enhancing the productivity and profitability of their clients.  When you hire a risk manager, you are essentially adding a team of professionals to your management team without putting them on your payroll.  The rest of this article discusses some of the distinguishing services of a risk manager.  It is critical to understand that these are not just service capabilities, rather hands-on, broadened services your company can expect from hiring a proven risk manager.

Services of a Risk Manager

Claim Prevention

One of the biggest advantages to hiring a risk manager is the securing of claim prevention strategies and training.  To prevent claims from occurring, we must educate our employees on how to work as safe as possible.  The first step is having the risk manager’s safety and loss control specialist review and renovate your company safety program.  The finished program is an up-to-date, custom safety program for your company and its operations.  A risk manager will also help your company roll out the new safety program and incorporate its content into prepared company safety meeting topics.  Successful claim prevention is a critical element of effective risk management.

Claims Management

When you hire a risk manager you can expect to secure a broader level of claims management and service.  The risk manager’s in-house claim management personnel manage claims on behalf of the employer as well as the employee.  From the side of the employer, the risk manager provides veteran claims specialists who aggressively reduce open claim reserves and close claims as soon as possible utilizing their technical experience and finesse to work with claims adjusters.  From the side of the employee, the risk manager helps the injured employee feel that they are truly the company’s most valuable asset.  The employee knows they will do whatever is necessary to make sure they receive proper medical care and help them get back to work as quickly as possible.  With the help of expert claims management, you will see notable reductions in your company’s claim frequency and severity.

Reduced Litigation    

Did you know that a work comp attorney will double the cost of a claim?  A true risk manager teaches every employee that their company, not an insurance company, ultimately pays the cost of a claim.  Employee perspectives and behaviors change when they understand that the lawyers filing work comp claims are the only ones that get rich.  The other two parties involved, the company and the employee, are both dramatically hurt by the litigation process.  Moreover, most injured employees are not trying to take advantage of the system and once they know they have an advocate looking out for their best interest, assisting with questions, and helping them return to work as soon as possible, they have no reason to approach an attorney. 

Fraud & Abuse Prevention 

Work comp fraud and abuse often creates the greatest frustration for companies in regards to insurance and most insurance brokers say there is no solution.  Although risk managers are not going to rehabilitate hardened criminals, the results show that the majority of employees respond to targeted education and training.  Injured employees are often not aware they are taking part in the abuse scheme.  Doctors and lawyers today are notorious for exaggerating claims and adding additional “injuries” such as psychiatric claims, sleep deprivation, or sexual dysfunction.  Through education, the employee learns what a wolf in sheep’s clothing looks like, which helps prevent a lot of unnecessary claim costs.  Moreover, we have seen numerous cases where our education inspires an employee to come forward and withdraw an existing workers’ compensation claim upon learning the truth about workers’ compensation fraud, the legal penalties of committing such felonies, and the negative financial impact on the company and its employees.

Cal OSHA Expertise

What happens if Cal OSHA pays you a visit or has to investigate a serious claim?  A risk manager has an in-house OSHA compliance expert to ensure your company is in full compliance.  Cal OSHA violations can be very costly to a company’s bottom line as well as their reputation, and regular inspections of your facility or jobsites by the risk manager are critical to staying Cal OSHA compliant.  A risk manger will help minimize such exposure so that the company can focus on its business, not fighting or paying OSHA fines. 

      Employee Education and Team Building

Would it be helpful if an employee thought more like an owner or a supervisor?  When was the last time a company’s CEO, CFO, or member of upper management filed a workers’ compensation claim?  One of the most important services of a true risk manager is providing employee training that creates greater employee understanding, and enhances their morale.  Even amongst risk managers, this is a unique service that only a select few risk managers provide to their clients.  It has been proven that once an employee understands the “why” behind working safe, they catch the vision of working hard and smart every day.  In fact, a company’s culture is transformed when the employees themselves take ownership of their safety program, its enforcement and when your employees truly feel that no amount of profit justifies the loss of a team member.

Improving Productivity

An interactive risk manager breaks away from the traditional model of working from the top down within an organization.  The approach of starting with employees and working up to management has not only secured improved safety results, but increased productivity.  If you treat your employees like they really are your greatest assets, they will become your partners in safety and take better care of your customers.  We often hear that our unique services accomplish more than just risk management; business owners even boast that their employees feel more valued as members of their corporate family as a result of our training.

Service Accountability

Providing all these services may appear like a lofty goal to most brokers, however risk managers create written service contracts with mutually determined priorities and deadlines so that client expectations are met.  When a company outsources its risk management, it also deserves to outsource the day-to-day administration too.  In fact, a proven risk manager should work for one of two potential grades, an “A” or an “F” because they understand their risk management stewardship and take it seriously.  Unlike some big brokers, risk managers create long-term client relationships based on the services they consistently provide as opposed to just promise.

The Bottom Line

Companies working with a risk manager achieve dramatically lower claim frequency and reduced claim severity.  These results clearly lead to bottom-line financial benefits, including dramatic decreases in long term insurance premiums.  However, immediate premium costs are also affected as underwriters negotiate the exchange of coverage for premium and they consider a multitude of factors to arrive at their final rates.  We have seen first-hand that companies using a risk manager secure higher discounts and ultimately lower premiums in exchange for implementing full service risk management programs.  After all, how many insurance brokers have spent enough face to face training time with their client’s employees that the employees all know their broker by name? 

Although most businesses are likely to experience rough water ahead in their workers’ compensation, we hope you can leverage this information to better protect your company.  We are confident that by taking the time assess the services available by upgrading to a risk manager, that you too can cultivate a company culture of greater safety, productivity and even profitability.

Workers' Comp Pure Premium Rate Set to Rise Again

Last November I wrote about the increase in the Pure Premium rate effective January 1, 2012.  The Insurance Commissioner approved another increase, to an average rate of $2.49 per $100 of payroll (an increase of about 8% over the January 1, 2012 average rate).

In the article I linked to above, I explain more about what the Pure Premium rate is and how it may impact your premiums and your business.  As I mentioned in that posting, your insurance broker can work with you and your team to effectively manage variables impacting your insurance premiums and help put you in the best position to control your insurance costs.  Information and education (including educating your workforce) are two of the most important weapons in your arsenal.  Some of these approaches are outlined in an article by Griff Griffith which is also posted this month.

Even though it may be too late to impact what may be happening with your rates if you are a July 1 renewal, it still makes sense to get with your broker and discuss action  steps, things you can change in your business now, to begin mitigating the costs and improve your position the next time you are up for renewal.

Architecture Billings Index - March 2012

Last year I wrote about this indicator and in that posting I provided an overview of what the measurement means relative to the building industry.  If you are not familiar with this index, I encourage you to click on the link at the beginning of this posting for an overview.  I thought it would make sense to provide an update to the numbers and see where we are one year later.

In a nutshell, the index suggests we are about in the same place we were one year ago.  Further, the regional trends are also holding steady.  The national Architecture Billings Index (ABI) came in at 50.4 for March 2012 (compared to 50.5 for March 2011).  Any number north of 50 indicates increased demand for design services (a leading indicator for building).  All regions in the U.S., with the exception of the West, were above 50.0 in March 2012.  The West came in at 46.6, slightly lower than around the same time last year.

So it's been more of the same in the West, a challenging environment that those of us participating in the building economy know all too well.  Hopefully we are bouncing along a bottom and there has been stabilization.  Some good news is that there are bright spots in some of the backlogs we're seeing, opportunities for good work do exist.  At the same time there are those really tough jobs with bad margins still being worked through in 2012.  Last year I stated that it would probably be a few more years before we returned to "times of meaningful growth and strength."  That is still most likely the case.  In the meantime those contractors who remain positive and keep doing what must be done in order to survive and thrive in these times will eventually be rewarded.  We had one contractor say recently he used to work from 7AM to 5PM, now he needs to work from 5AM to 7PM to keep things moving along.  Every contractor needs to commit to work smarter and yes, harder in these challenging times to get to better days which will return.

Do You Have a Concentration Risk in Your Net Worth?

Most small business owners put everything they have into their businesses as they are growing them.  They are entrepreneurs, risk takers and are successful in part because of their willingness to take on risk.  Along the way, they build net worth and value in their business.  They also build a concentration in one stock, the stock of their operating company, comprising a large percentage of their personal net worth.  For most business owners the value in the stock of their operating company, along with the equity in their homes, will represent the vast majority of their net worth.

For most businesses owners, developing this concentration is almost impossible to avoid.  For some it is by design.  Many years ago I was touring a manufacturing operation with the owner who was giving me a tour of his facilities.  I asked him about other investments he had and I referenced the stock market’s activity that day.  We were up on the second floor of his warehouse and he motioned with his arm toward the floor below and said “this is my stock market”.  He went on to tell me he had no other investments and everything was in his business.  Although that works as long as your business works having most, if not all, of your eggs in one basket is generally a dangerous endeavor.  

It’s understood that in order to grow one’s business, capital is required and retaining profit inside the company is essential to its ongoing operations.  The challenge comes later in one’s career, as significant value in the business is accreted, to diversify holdings such that the concentration your business represents in your net worth is mitigated.  There are no hard and fast rules regarding how large this owner operated business concentration should be.  The goal to reduce the portion that your business value represents as a percentage of your overall net worth may not be achievable until your business hits the maturity stage of its life cycle.  That being said, the purpose of this article is to bring the issue to the forefront and have the business owner develop a plan to diversify away from this concentration.  

A goal I have discussed with business owners is aiming for the value of their business to comprise 25% or less of their total net worth.  Any business owner, particularly a construction firm, should seek diversification and mitigate any concentrations in their net worth.  There are a number of ways, after your business has reached maturity, to take some of the chips off the table.  These options include sale of minority stakes to key employees who desire, and are worthy of, equity ownership, sale of non-voting stock (in order to retain control), ESOPs, distributions of excess working capital (yes, this is still possible in 2012 in select cases) just to name a few.  The option you choose will depend on your particular circumstances.  Be sure to include the bond company and bank in any discussion regarding your options.  You don’t ever want to do anything to adversely affect your ability to obtain credit as you do your planning.  As always, consult with your trusted advisors as well.

We’ve all heard that the two of the strongest pillars of wealth are 1) knowing how to make money and 2) knowing how to keep it.  As I’ve cited before, the old saying goes all contractors are one bad job away from going out of business.  The execution of a plan for diversification is essential in keeping a lifetime of work and wealth accumulation intact and provides peace of mind allowing the entrepreneur to sleep easier.

Measure Twice, Cut Once - Maintain Quality in the Estimating Process

Work is hard to come by these days, with all the bidders on jobs and razor thin margins, building quality backlog is not an easy task.  In talking with contractors, I've heard that it requires increased bid activity/volume in this competitive environment to win the work needed to keep the business moving forward.  On the face of it there doesn't seem much to take issue with regarding that statement.  I'm generally in agreement with it as long as the quality and integrity of the estimating process is maintained.

If it takes 100 hours to properly estimate a certain job in the "normal" times, it should take 100 hours to estimate that same job in these more challenging times.  What I've heard from some contractors in recent months is that because they are increasing bid activity with the same or even fewer estimators, the per job bid time is sometimes significantly less.  Some bids that should have taken, say, the 100 hours referenced above are getting bid in as little as 30 or 40 hours.  In order to get the quantity of bids higher, the amount of time per bid has dropped decreasing attention to detailed specifications being called for.  Mistakes are being made.  Whether it is a full line item/trade missed, or parts of the scope of a trade, missing scope of work in your bid will certainly unintentionally improve your chances of winning the job.  The obvious problem becomes how to figure your way out of the hole and mitigate your losses or hopefully make nominal profit.

It is far more important, as with most things in life and business, to maintain quality over quantity.  There's an old saying in the construction business that every contractor is one or two bad jobs away from going out of business.  This is especially true when balance sheets/capital structures have been weakened these past few years by losses.  Be sure to maintain quality in your business processes to ensure mistakes you can ill afford to make are avoided...Measure Twice, Cut Once.

The Importance of Buy-Sell Agreements

As the business owner’s average age continues to increase given the demographics of our population, there are a number of issues that may not have been perceived as important a few years ago that gain increasing attention as time marches on.  The truth is that these issues (e.g. buy sell-agreements, business continuity plans, etc.) have always been important.  There are a number of ways one can exit his/her business.  Many of those exit plans are voluntary and planned while some are not.  These agreements are often times overlooked as there is no sense of immediate need/urgency, etc.  They also generally deal with less than pleasant scenarios that people prefer not to think about.  The reality is that if you want to take care of your spouse and children, you really need to think about how your business is going to produce a liquidity event, in a timely, efficient and fair (think valuation) manner so your family can be well taken care of.  It can also be helpful to you as a shareholder if for some reason you find yourself, or your partner, having to divest from the business for whatever reason.

In basic terms, buy-sell agreements deal with situations whereby a business owner leaves the business through death, incapacitation or some other unexpected set of circumstances.  These agreements are also important in that if your partner is the one who is unexpectedly unable to continue in the business, the buy-sell agreement is the vehicle which will preclude his/her spouse from becoming your business partner.  This last item alone can be very motivational for business owners to address this issue.  

Some of the key terms addressed via a buy-sell agreement include who may buy the business interest, the events that trigger the agreement and the price to be paid for the business interest.  All of these are very important elements and must be addressed thoroughly and with professionals who are expert in preparing such agreements.  There are a few major, critical considerations which also must be addressed when structuring buy-sell agreements; 1) valuation criteria and 2) properly funding the buy-sell agreement.

The valuing of a business, or a share in a business, is an undertaking that can produce varied results.  I’ve said many times over the years you can have one valuation expert arrive at different valuations for different purposes (there are a number of reasons a company may need to obtain a valuation) at the same point in time.  You can also have different valuation firms arrive at very different results all valuing the business for the same purpose at the same time.  The best way to mitigate the potential for an unexpected and/or unfair result is to hire valuation experts familiar with your industry and business.  One size does not fit all when it comes to valuation and the selection of the right valuation firm is critical.  Valuation is contingent on many factors including methodologies, styles and perspectives, who the valuation firm is hired by (buyer or seller), etc.  Within the context of a buy-sell agreement, valuation is further challenging in that the principals are not necessarily looking for a value today, rather the goal is to ascribe a value to a business, or share of a business, at some unknown point in the future. 

The best way to handle the valuation issue in a buy-sell agreement is to have a valuation performed in the first year and then get annual, less expensive updates to that valuation in subsequent years.  Using this process, the many variables associated with properly valuing a business can be addressed given the set of conditions present at that time.  It is impossible to build a formula that will successfully process all of the variables that can change in the future.  That being said, in addition to building in a valuation requirement, it makes sense to insert a formulaic approach into your buy-sell agreement if for some reason a valuation wasn’t performed at the scheduled time(s) as a backup safety valve.  A dynamic formula is better than none at all and can be critical in the absence of a valuation being performed.  Arriving at a fair value for the business is essential to ensuring you and your family’s interests are protected.

Another important consideration in structuring buy-sell agreements is the funding of the liquidation event.  Depending on the particular set of circumstances, there are a variety of ways to fund buy-sell agreements so that the business is not disrupted.  Also, insurance can be an effective tool serving as value preservation in the event that the loss of a key individual adversely affects the valuation of the business.  Generally speaking, there are a number of insurance products used to fund the buy-sell agreements so that the business has the liquidity it needs to pay out the proper value of the business to the appropriate parties.  

A buy-sell agreement that isn’t properly funded is similar in many ways to establishing a living trust without funding it (i.e. converting title of assets into the trust, etc.)  It ends up causing additional heartache and stress and the good intentions of putting such structures in place are nullified by the failure to complete the job and address all the issues up front.  If you do not have a buy-sell agreement in place, or if you are unsure if it’s properly funded, you should reach out to your trusted advisor team and address it immediately.  If your agreement hasn’t been reviewed in a number of years you should revisit it to ensure it will achieve your objectives so you and your family are protected in the event the agreement is triggered.

Changes to Mechanic's Lien and Stop Notice Laws

In September 2010, the Governor signed into law SB 189 which changes certain aspects of the lien law code.  The changes are generally effective July 1, 2012 (unless otherwise noted in the bill).  It is important to familiarize yourself with these changes.  Atkinson, Andelson, Loya, Ruud & Romo did a nice job summarizing the salient points in a two page summary below...